1. In graphing a Security Market Line (assuming perfect markets and an Ideal CAPM world), you find that project A has Beta = 2.25 and a return of 7%, and project B has Beta = 3.25 and a return of 9%. From these two data points, determine the risk-free rate of return in the market.

 

2. In graphing a Security Market Line (assuming perfect markets and an Ideal CAPM world), you find that project A has Beta = 1.5 and a return of 9.5%, and project B has Beta = 2.5 and a return of 11.5%. From these two data points, determine the predicted rate of return for a stock with Beta=1.

 

3. The expected rate of stock market return is 15% and the risk-free rate is 5%. What is the appropriate cost of capital for a project with Beta = 1.5? (Report cost of capital as a decimal. 10% cost of capital = .1)

 

4. Solve for an appropriate project beta if the cost of capital is 10%, and the market is such that the risk-free rate is 4% and the expected market return is 11%.

 

5. A project has two possible outcomes; the good outcome returns $10000 next year and occurs 90% of the time, while the bad outcome is total failure, returning $0 the other 10% of the time. If the risk free interest rate is 4%, the expected market return is 8%, and the project Beta is 2.5, what must the price of the bond be?

 

 

6. You are tasked with estimating the beta of a government-owned firm, and have found several pieces of data. A comparable company has a listed equity beta of 1.5, but a debt-to-asset ratio of 1/2. If the firm you are tasked with analyzing has a debt-to-asset ratio of 0.9, and the debt is risk-free (the firm is government-owned), what can you conclude is the equity beta of this firm?

 

7. What happens to a projects appropriately priced cost of capital under CAPM if there is a sudden shock to its market-beta? In other words, what is the effect of an increase in the project beta on E(r_i)?

 

 

8. Consider a sudden positive shock to the expected return of the market, with no noticeable change to the risk-free rate of return or CAPM inputs. What are the implications for a projects cost of capital if it has positive Beta?

 

 

9. A $1000 municipal bond is in danger of default, and you are a bond-holder trying to sell the asset at a fair price. The municipality is facing uncertainty in the facing of decreasing tax revenues, but is expected to repay the bond in its entirety with probability 25%. There is also a 37.5% probability of paying back only $800, and otherwise will only afford to pay $500 with probability 37.5%. Current market conditions indicate a 2% risk-free rate of return and a 5.5% equity premium, and the bond has a beta of 0.5. What would you conclude is a fair CAPM market price, in dollars, for this bond?

 

10. A junk bond with a beta of 0.4 will default with 20% probability. If it does, investors receive only 60% of what is due to them. The risk-free rate is 3% per annum and the risk premium is 5% per annum. What is the price of this bond, its promised rate of return, and its expected rate of return?

 

11. A Fortune 100 firm is financed with $15 billion in debt and $5 billion in equity. Its historical equity beta has been 2. If the firm were to increase its leverage from $15 billion to $18 billion and use the cash to repurchase shares, what would you expect its levered equity beta to be? We assume that the debt beta of the Fortune-100 firm is about 0.