FIN500 Module 3 Problem Set Questions

Problem 1The expected returns earned from investment in the stock of two companies, Company A andCompany B, are shown in the following table. Use the table to complete parts (a) through (c)below.DemandProbabilitExpectedExpectedfory ofReturn: Stock Return: StockProductDemandABStrong0.340%20%Normal0.4520%5%Weak0.250%(5%)(a) Compute the expected rates of return for each stock.(b) Compute the standard deviations for each stock.(c) Compute the coefficient of variation for each stock. Based on the coefficient of variation,which stock has the higher risk for investment?Problem 2The expected returns earned from investment in the stock of two companies, Company A andCompany B, are shown in the following table. Assume a two-stock portfolio with $25,000 inCompany A and $75,000 in Company B. Compute the expected return on the portfolio.DemandforProductStrongNormalWeakProbability ofDemand0.30.450.25ExpectedReturn: StockA40%20%0%ExpectedReturn: StockB20%5%(5%)Problem 3Suppose you have a portfolio consisting of three stocks. You invest a total of $200,000 in thestocks. The investments and beta for the stocks are shown in the following table. Use the table tocomplete parts (a) through (c) below.StockInvestmentBeta1$60,0001.252$40,000(0.5)3$100,0001.5(a) Assume the risk-free rate is 5.5% and the expected return for the market is 10%. Estimate theappropriate required rate of return for each stock.(b) Compute the portfolio beta.(c) Find the portfolios required rate of return, assuming the same risk-free rate and expectedreturn for the market as in part (a).Problem 4A stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return,and a 25% chance of producing a -18% return. What is the stock’s expected rate of return?Problem 5Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a betaof 1.20. You are in the process of buying 1,000 shares of stock selling at $10 a share and addingit to your portfolio. The newly purchased stock has an expected return of 13.0% and a beta of1.50. The total value of your current portfolio is $90,000. What will the expected return and betaon the portfolio be after the purchase of the new stock?Problem 6Calculate the required rate of return for a stock assuming that (1) investors expect a 4.0% rate ofinflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4)the stock has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5years.