Question
Consider the following table, which gives a security analyst's expected return on two stocks for two particular market returns: Mark Performance Market return Aggressive Stock
Consider the following table, which gives a security analyst's expected return on two stocks for two particular market returns:
Mark Performance | Market return | Aggressive Stock | Defensive Stock |
Low | 5% | -2% | 4% |
High | 15% | 24% | 8% |
Required:
a. What are the betas of the two stocks? (2 marks)
b. What is the expected rate of return on each stock and the market if the probability of low market performance is 40% and high market performance is 60%? (3 marks)
c. If the T-bill rate is 3% and the probability of low market performance is 40% and high market performance is 60%, calculate required return and alpha for each stock by using securities market line (SML). (3 marks)
d. Draw a securities market line (SML) and show the two stocks in the graph. Discuss which stock underperformed the market and which stock over-performed the market. (3 marks)
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