There are two stocks in the market: Stock A and Stock B. The price of Stock A
Question:
There are two stocks in the market: Stock A and Stock B. The price of Stock A today is $67. The price of Stock A next year will be $40 if the economy is in a recession, $76 if the economy is normal, and $89 if the economy is expanding. The probabilities of recession, normal times, and expansion are .10, .65, and .25, respectively. Stock A pays no dividends and has a correlation of .73 with the market portfolio. Stock B has a standard deviation of 63 percent, a correlation with the market portfolio of .35, and a correlation with Stock A of .50. The market portfolio has a standard deviation of 20 percent. The risk-free rate is 4 percent and the market risk premium is 7.5 percent. Assume the CAPM holds.
a. If you are a typical, risk-averse investor with a well-diversified portfolio, which stock would you prefer? Why?
b. What are the expected return and standard deviation of a portfolio consisting of 70 percent of Stock A and 30 percent of Stock B?
c. What is the beta of the portfolio in part (b)?
Stocks or shares are generally equity instruments that provide the largest source of raising funds in any public or private listed company's. The instruments are issued on a stock exchange from where a large number of general public who are willing... Expected Return
The expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these... Portfolio
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly...
Step by Step Answer:
a A typical riskaverse investor seeks high returns and low risks For a riskaverse investor holding a welldiversified portfolio beta is the appropriate ...View the full answer
Corporate Finance Core Principles and Applications
ISBN: 978-1259289903
5th edition
Authors: Stephen Ross, Randolph Westerfield, Jeffrey Jaffe, Bradford Jordan
