UGBA103_Pb_Set5_Solutions

# UGBA103_Pb_Set5_Solutions - Problem set#5 Solutions GSI...

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Problem set #5 –Solutions GSI: Florent Rouxelin 1. Some relevant data pertaining to three Dow-Jones stocks over the January 1971- December 1975 period are: Stock σ(Ri) βi A ALCOA .093 .662 B Eastman Kodak .070 .979 C Union Carbide .085 1.231 The pairwise correlations between the returns of these three securities are: ρ ab = .137 ρ ac = .476 ρ bc = .422 Using the capital asset pricing model and assuming that E(R m ) = 0.010 per month and R f =.002 per month, calculate the expected return on each stock. Why is E(R B ) > E(R A ) when σ(R A ) > σ(R B )? E{ri] = rf + β im (rm-rf) E{ra] = rf + βa (rm-rf) => .002 + .662 (.010-.002)=.73% E{rb] = rf + βb (rm-rf) =>.002 + .979 (.010-.002)=.10% E{rc] = rf + βc (rm-rf) =>.002 + 1.231 (.010-.002)=.12 While A has more risk, more of that risk is idiosyncratic, or diversifiable away, leaving B with more systematic risk as measured by Beta. 2. The following data have been developed for the GlueFast company, a manufacturers of adhesives: State Probability Market Return R m Firm Return R i 1 .1 -.15 -.30 2 .3 .05 0 3 .4 .15 .20 4 .2 .20 .50 The risk free rate is 6%. Calculate the following: a. The expected market return

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UGBA103_Pb_Set5_Solutions - Problem set#5 Solutions GSI...

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