Owais Husain PhD.



Exercise

Risk and Rates of Return

Question :1 What would you expect the nominal rate of interest to be if the real rate is 4.5 percent and the expected inflation rate is 7.3 percent? (Inflation & Interest rate)

Question :2 Assume the expected inflation rate is 3.8 percent. If the current real rate of interest is 6.4 percent, what should the nominal rate of interest be? (Inflation & Interest rate)

Question :3 Syntax Inc., is considering an investment in one of two common stocks. Given the information that follows, which investment is better, based on risk (as measured by the standard deviation) and return? (Expected rate of return and risk)

| Common Stock A |Common Stock B |

|Probability |Return |Probability |Return |

|.30 |11% |.20 |-5% |

|.40 |15% |.30 |6% |

|.30 |19% |.30 |14% |

| | |.20 |22% |

Question :4 Friedman manufacturing Inc., has prepared the following information regarding two investments under consideration. Which investment should be accepted? (Expected rate of return and risk)

|Common Stock A |Common Stock B |

|Probability |Return |Probability |Return |

|.20 |-2% |.10 |4% |

|.50 |18% |.30 |6% |

|.30 |27% |.40 |10% |

| | |.20 |15% |

Question :5 Johnson Manufacturing, Inc., is considering several investments. The rate on treasury bills is currently 6.75 percent, and the expected return for the market is 12 percent. What should be the required rates of return for each investment (using CAPM?)

|Security |Beta |

|A |1.50 |

|B |.82 |

|C |.60 |

|D |1.15 |

Question :6 CSB, Inc., has a beta of .765. if the expected market return is 11.5 percent and the risk free rate is 7.5 percent, what is the appropriate required rate of return of CSB (using the CAPM)?

Question:7 The expected return for the general market is 12.8 percent, and the risk premium in the market is 4.3 percent. Tasaco, LBM and Exxos have betas of .864, .693, and .575, respectively. What are the appropriate required rates of return for the three securities?

Question: 8 Your own Portfolio consisting of the following stocks.

|Stock |Percentage of Portfolio |Beta |Expected return |

|1 | 20% |1.00 | 16% |

|2 | 30% |0.85 | 14% |

|3 | 15% |1.20 | 20% |

|4 | 25% |0.60 | 12% |

|5 | 10% |1.60 | 24% |

The risk free rate is 7 percent. Also, the expected return on the market portfolio is 15.5 percent.

a) Calculate the expected return on your portfolio. (Hint: The expected return of a portfolio equals the weighted average of the individual stock’s expected return, where the weights are the percent invested in each stock.

b) Calculate the portfolio Beta.

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