Assume the market portfolio consists only of three stocks as follows Stock Current Market Share Price Shares Outstanding (in millions) Market capitalization (in millions $) Weight Beta E(R) Sun $25 400 0 3 3 3 Earth $50 250 1 6 11 1 Moon 12 5 200 0 8 6 3 The last column shows the expected return over the next year Given above information, answer the following questions Calculate the market capitalization value of each stock 3 points Determine the weighting for each stock 3 points If you have an investment budget of $25,000 and want to invest in stocks Sun , Earth , and Moon , in the proportions (weights) as in (b) above, answer the following questions c1) How much would you invest in stock Sun How many shares 2 points c2) How much would you invest in stock Earth How many shares 2 points c3) How much would you invest in stock Moon How many shares 2 points Calculate the beta of the market portfolio 2 points What is the expected return on the market portfolio 2 points Determine the risk free rate Hint you can use any stock and its associated beta to obtain R f , from the market equilibrium condition of the SML 4 points Based on your results above, compute the expected return on stock Earth using the CAPM 2 points Olivia Smart, a successful investment analyst with an impressive record, predicts that Earth stock will reach a price of $60 over the next year, which is based on her analysis of the firms fundamentals (e g , analysis of financial ratios, risk, capital expenditures, industry and macroeconomic indicators, and others) Earth stock does not pay dividends Based on this information h1) Estimate the holding period return on Earth Stock 2 points h2) Would you invest in Earth stock Yes, no, justify your answer 2 points h3) Is Earth stock underpriced, overpriced or fairly priced Justify quantitatively by computing the fair value of the stock 2 points h4) Explain an investment strategy (if any) to profit from Olivias prediction 2 points

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Posted on Sep 11, 2024

Assume the market portfolio consists only of three stocks as follows:

Stock	Current Market Share Price	#Shares Outstanding (in millions)	Market capitalization (in millions $)	Weight	Beta	E(R)
Sun	$25	400	?	?	0.3	3.3%
Earth	$50	250	?	?	1.6	11.1%
Moon	12.5	200	?	?	0.8	6.3%

The last column shows the expected return over the next year.

Given above information, answer the following questions:

Calculate the market capitalization value of each stock. [3 points]
Determine the weighting for each stock. [3 points]
If you have an investment budget of $25,000 and want to invest in stocks Sun, Earth, and Moon, in the proportions (weights) as in (b) above, answer the following questions:

c1) How much would you invest in stock Sun? How many shares? [2 points]

c2) How much would you invest in stock Earth? How many shares? [2 points]

c3) How much would you invest in stock Moon? How many shares? [2 points]

Calculate the beta of the market portfolio. [2 points]
What is the expected return on the market portfolio? [2 points]
Determine the risk free rate. [Hint: you can use any stock and its associated beta to obtain R_f, from the market equilibrium condition of the SML]. [4 points]
Based on your results above, compute the expected return on stock Earth using the CAPM. [2 points]
Olivia Smart, a successful investment analyst with an impressive record, predicts that Earth stock will reach a price of $60 over the next year, which is based on her analysis of the firms fundamentals (e.g., analysis of financial ratios, risk, capital expenditures, industry and macroeconomic indicators, and others). Earth stock does not pay dividends. Based on this information: