hat is the expected rate of return on a portfolio with a beta of 1.5

hat is the expected rate of return on a portfolio with a beta of 1.5


Suppose the rate of return on 3-month T-Bill is 4%

Subject: Business    / Finance   
Question
1) Suppose the rate of return on 3-month T-Bill is 4%. Suppose also that the
expected rate of return required by the market for a portfolio with a beta of 0.8 is 12%.
According to the capital asset pricing model:

(a) What is the expected rate of return on a portfolio with a beta of 1.5?

(b) Suppose you consider buying a share of stock A at $20. The stock is expected to pay
$3 dividends next year and you expect it to sell then for $19. The stock risk has been
evaluated at ? = 0.5. Is the stock underpriced, overpriced, or fairly priced? How should
you trade according to your own belief?

(c) Plot stock A on the SML graph.

2. As a financial analyst, you are tasked with evaluating a capital budgeting project. You
were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 4% and the expected market rate of return is 11%. Your company has a beta of 1.4 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, what is the appropriate hurdle rate?

3) Given the following two stocks A and B

A expected rate of return=0.12 Beta=1.2
B expected rate of return=0.14 Beta=1.8

If the expected market rate of return is 9% and the risk-free rate is 5%, which security
would be considered the better buy and why?

4) Consider the multifactor APT with two factors. Stock A has an expected return of
17.6%, a beta of 1.45 on factor 1 and a beta of .86 on factor 2. The risk premium on the
factor 1 portfolio is 3.2%. The risk-free rate of return is 5%. What is the risk-premium on
factor 2 if no arbitrage opportunities exit?

5)Consider two firms: Electricity and Jewellery. Electricity is a regulated electric-power
utility, and Jewellery is a well-known luxury jewellery retailer. The multifactor (APT) model
of security returns for two stocks has the following information:
Factor Factor Beta for Electricity Factor Beta for Jewellery Factor Risk Premium
Inflation 0.6 0.2 5%
Real GDP 0.5 0.8 8%
Gold Price -0.1 1.5 2%

(a) If T-bills currently offer a 5% yield, find the expected rate of return on two stocks if
the market views the stocks are fairly priced.

(b) If the expected rate of return on Electricity were 11%, would there be an arbitrage
opportunity? If so, please specify the arbitrage opportunity using three factor portfolios
and risk-free asset.

(c) Jewellery firm plans to diversify the current product and enter into a new market. Then Jewellery’s stock will be less sensitive to gold price changes. If beta loading on gold price factor drops to 1.0, how much will the expected return of Jewellery stock change?

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