Which stock is “riskier”? Stock II has higher SD and hence higher total risk and is riskier. #6: Suppose you observe the following situation: Security Beta Expected Return Pete Corp 1.35 0.132 Repete Co. 0.80 0.101 Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk-free rate? Pete Corp: 0.132 = Rf + 1.35(Rm – Rf) Repete Co: 0.101 = Rf + 0.8 (Rm – Rf) Solve simultaneously to get Rf =5.59% and Rm= 11.23%
#7: You are managing a portfolio of 6 stocks, which are held in equal dollar amounts. The current beta of the portfolio is 1.4, and the beta’s of Stock A is 1.8 and of Stock B is 2.0, respectively. If Stock A and Stock B are sold and the proceeds used to purchase 2 replacement stocks, what does the average beta of these 2 replacement stocks have to be to reduce the portfolio beta to 1.25? 1.4 = 1/6 (1.8 + 2 + beta of 4 other stocks) Beta of 4 other stocks = 4.6 1.25 = 1/6 (beta of 2 replacement stocks + 4.6) Beta of 2 replacement stocks = 2.9 Average beta = 2.9/2 = 1.45
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- Fall '18
- Capital Asset Pricing Model, Risk in finance, Stock B, Stock A