Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Murphy, who has retired for several years, is considering investing in two stocks: A and B. The returns and other related estimates for the two

Murphy, who has retired for several years, is considering investing in two stocks: A and B. The returns and other related estimates for the two stocks under different states of the world in the coming year are estimated as follows:

Rate of Return if State Occurs

State of the World Probability Stock A Stock B

Good 0.1 40% -6%

Normal 0.7 24% 18%

Bad 0.2 -14% 30%

Variables Stock A Stock B

Expected Return --- 18%

Standard Deviation --- 9.3%

Beta 1 0.75

(a) Calculate the expected rate of return and standard deviation of Stock A.

(b) If Murphy could only invest in either Stock A or Stock B, which asset should he choose? Explain

(c) Assume that the covariance between Stock A and Stock B is -0.01055842 or -105.5842%^2 . Compute the expected return and standard deviation of returns of Portfolio AB in which 40% of its value is invested in Stock A and the remainder in Stock B.

(d) If Murphy could choose to invest in between Stock A, Stock B and the Portfolio AB, which should he invest in? Explain.

(e) Assume the risk-free rate is 4% and the market risk premium is 19.5%. Based on CAPM, should Murphy invest in the Portfolio AB?

Step by Step Solution

There are 3 Steps involved in it

Step: 1

a The expected rate of return for Stock A is 18 and the standard deviation is approximately 1669 b B... blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Accounting Principles

Authors: Jerry Weygandt, Paul Kimmel, Donald Kieso

12th edition

1119132223, 978-1-119-0944, 1118875052, 978-1119132226, 978-1118875056

More Books

Students also viewed these Finance questions