PART 1

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%.

Stock	Expected Return	Standard Deviation	Beta
A	5.60%	15%	0.6
B	7.70%	15%	1.2
C	8.75%	15%	1.5

Assume that the market is in equilibrium, with the required rate of returns equal to expected returns.

2. True or False: The beta for a fund is equal to the weighted average of the betas of the individual stocks in the fund.

A. True

B. False

3. 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.

This information implies that the required rate of return for Fund P is approximately .

4. True or False: The standard deviation for Fund P is less than 15%.

A. True

B. False

PART 2:

Now its time for you to practice what youve 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%.

Stock	Expected Return	Standard Deviation	Beta
A	7.10%	15%	1.2
B	8.90%	15%	1.8
C	9.80%	15%	2.1

Using SML equation, you can solve for the market risk premium 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.

1. The beta for Fund P is approximately ___________ .

You have the market risk premium, the beta for Fund P, and the risk-free rate.

2. this information implies that the required rate of return for Fund P is approximately________ .

3. Which of the following is the reason why the standard deviation for Fund P is less than 15%?

A. The stocks in Fund P are not perfectly correlated.

B. Any two stocks in Fund P have a correlation coefficient of 1.

C. The stocks in Fund P each have differing standard deviations.

D. The stocks in Fund P are perfectly correlated.