week09_TutorialAnswers - SCHOOL OF BANKING AND FINANCE...

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FINS 1613 Tutorial Answers 1 SCHOOL OF BANKING AND FINANCE FINS1613 BUSINESS FINANCE Semester 2, 2010 TUTORIAL ANSWERS WEEK 9 – Beta and CAPM Multiple-choice Questions 1. Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.) a. When held in isolation, Stock A has greater risk than Stock B. b. Stock B would be a more desirable addition to a portfolio than Stock A. c. Stock A would be a more desirable addition to a portfolio than Stock B. d. The expected return on Stock A will be greater than that on Stock B. e. The expected return on Stock B will be greater than that on Stock A. Answer is d. 2. What is the expected return on asset A if it has a beta of 1.2, the expected return on the market is 10%, and the risk-free rate is 4%? a. 8.8% b. 9.0% c. 10.0% d. 11.2% e. Not enough information Answer is d. Capital Asset Pricing Model (CAPM) ( ) ( ) ˆˆ ˆ 4% 1.2 10% 4% 11.2% i RF i M RF k k bk k = +− = + −=
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FINS 1613 Tutorial Answers 2 3. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements is most correct? a. Stock Y's return this year will be higher than Stock X's return. b. Stock Y's return has a higher standard deviation than Stock X. c. If expected inflation increases (but the market risk premium is unchanged), the required returns on the two stocks will increase by the same amount. d. If the market risk premium declines (leaving the risk-free rate unchanged), Stock X will have a larger decline in its required return than will Stock Y. e. If you invest $50,000 in Stock X and $50,000 in Stock Y, your portfolio will have a beta less than 1.0, provided the stock returns on the two stocks are not perfectly correlated. Answer is c. Statement a is false; Y has a higher required return because it is more risky, but it may still end up actually earning a lower return than X. Statement b is false; beta tells us about the covariance of the stock with the market. It tells us nothing about the stocks' individual standard deviations. Statement c is correct from the CAPM: k s = k RF + (k M - k RF )b. Statement d is false from the CAPM. Statement e is false; the portfolio beta, b p , is calculated as (0.5 x 0.5) + (0.5 x 1.5) = 1.0. 4. Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15 percent, a beta of 1.6, and a standard deviation of 30 percent. The returns of the two stocks are independent--the correlation coefficient, r, is zero. Which of the following statements best describes the characteristics of your portfolio? a. Your portfolio has a beta equal to 1.6 and its expected return is 15 percent. b. Your portfolio has a standard deviation of 30 percent and its expected return is 15 percent. c. Your portfolio has a standard deviation less than 30 percent and its beta is greater than 1.6.
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This note was uploaded on 01/09/2012 for the course FINS 1613 taught by Professor Drkhshim during the Three '10 term at University of New South Wales.

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week09_TutorialAnswers - SCHOOL OF BANKING AND FINANCE...

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