Consider the following information for Stocks A, B, and C. The returns on the three stocks, whille positively correlated, are not perfectly correlated. The risk-free rate is 3.50%. Let ri be the expected retum of stock i,rMV represent the risk-free rate, b represent the Beta of a stock, and rM represent the market return. Assume that the market is in equilibrium, with the required rate of retums equal to expected hotums. According to the video, which equation most dosely describes the relationship between required returns, beto, and the market risk premium? r1=rRF+b(rM+rRj)ri=rRF+b(rMrRr)ri=rRFb(rMrRj)ri=rRF+rMHMb Hint: Recall that because the market is in equilibrium, the required rate of return is equal to the expected rate of return for each stock. Using the equation you just identified, you can solve for the market risk premlum which, in this case, equals approximately Consider Fund P, which has one third of its funds invested in each of stock A,B, and C. True or False: The beta for a fund is equal to the weighted average of the betas of the individual stocks in the fund. True False Using your answer to the previous question, the beta for Fund P is approximately You have the market risk premium, the beta for Fund P, and the risk-free rate. Hint: Recall that because the market is in equilibrium, the required rate of retum is equal to the expected rate of return for each stock: This information implies that the required rate of return for fund is approximately True or False: The standard deviation for Fund P is iess than 10%. True False Now it's time for you to practice what you've learned. Consider the following information for Stocks A, B, and C. The returns on the three stocks, while positively correlated, are not perfectly correlated. The risk-free rate is 3.50%. Let r1 be the expected retum of stock i,rRF represent the risk-free rate, b represent the Beta of a stock, and rM represent the market return. Using SML equation, you can solve for the market risk premium which, in this cose, equals approximately Consider Fund P, which has one third of its funds invested in each of stock A,B, and C. The beta for Fund P is approximately You have the market risk premium, the beta for Fund P, and the risk-free rate. Hint: Recall that because the market is in equilibrium, the required rate of return is equal to the expected rate of retum for each stock: This information implies that the required rate of return for Fund P is approximately Thich of the following is the reason why the standard deviation for Fund P is less than 10% ? The stocks in Fund P are not perfectly correlated. The stocks in Fund P each have differing standard deviations. The stocks in Fund P are perfectly correlated. Any two stocks in Fund P have a correlation coefficient of 1
