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5-3 a. No, it is not riskless. The portfolio would be free of default risk
and liquidity risk, but inflation could erode the portfolio’s
purchasing power. If the actual inflation rate is greater than that
expected, interest rates in general will rise to incorporate a
larger inflation premium (IP) and--as we shall see in Chapter 7--the
value of the portfolio would decline.
If risk aversion increases, the slope of the SML will increase, and so
will the market risk premium (kM - kRF). The product (kM - kRF)bj is the
risk premium of the jth stock. If b j is low (say, 0.5), then the
product will be small; RPj will increase by only half the increase in
RP M .
However, if bj is large (say, 2.0), then its risk premium will rise by
twice the increase in RPM.
5-8 No. For a stock to have a negative beta, its returns would have to
logically be expected to go up in the future when other stocks’ returns
were falling. Just because in one year the stock’s return increases
when the market declined doesn’t mean the stock has a negative beta. A
stock in a given year may move counter to the overall market, even
though the stock’s beta is positive.
σ 2
= 712.44; σ = 26.69%.
26.69%
CV = = 2.34.
11.40%
kM = 5% + (6%)1 = 11%.
k when b = 1.2 = ?
k = 5% + 6%(1.2) = 12.2%.
5-6 a. k̂ = ∑ Pk
i=1
i i .
b. σ = ∑ (k
i=1
i
− k̂)2 Pi .
c. 1. kM increases to 16%:
$142,500 $7,500
5-8 Old portfolio beta = (b) + (1.00)
$150,000 $150,000
1.12 = 0.95b + 0.05
1.07 = 0.95b
1.1263 = b.
Alternative Solutions:
$400,000 $600,000
5-9 Portfolio beta = (1.50) + (-0.50)
$4,000,000 $4,000,000
$1,000,000 $2,000,000
+ (1.25) + (0.75)
$4,000,000 $4,000,000
bp = (0.1)(1.5) + (0.15)(-0.50) + (0.25)(1.25) + (0.5)(0.75)
= 0.15 - 0.075 + 0.3125 + 0.375 = 0.7625.
kR = 7% + 6%(1.50) = 16.0%
kS = 7% + 6%(0.75) = 11.5
4.5%
c. kX = 6% + 5%(0.9)
kX = 10.5%.
kY = 6% + 5%(1.2)
kY = 12%.
d. kX = 10.5%; k̂ X = 10%.
kY = 12%; k̂Y = 12.5%.
e. bp = ($7,500/$10,000)0.9 + ($2,500/$10,000)1.2
= 0.6750 + 0.30
= 0.9750.
kp = 6% + 5%(0.975)
kp = 10.875%.
f. If RPM increases from 5% to 6%, the stock with the highest beta
will have the largest increase in its required return.
Therefore, Stock Y will have the greatest increase.
Check:
kX = 6% + 6%(0.9)
= 11.4%. Increase 10.5% to 11.4%.
kY = 6% + 6%(1.2)
= 13.2%. Increase 12% to 13.2%.
ks = 6% + (6.5%)1.7 = 17.05%.
5-14 In equilibrium:
kJ = k̂J = 12.5%.
kJ = kRF + (kM - kRF)b
12.5% = 4.5% + (10.5% - 4.5%)b
b = 1.33.
k = kRF + (RPM)b
12.5% = 5% + (RPM)1.0
7.5% = RPM.
Now, you can use the RPM, the kRF, and the two stocks’ betas to
calculate their required returns.
Bradford:
kB = kRF + (RPM)b
= 5% + (7.5%)1.45
= 5% + 10.875%
= 15.875%.
Farley:
kF = kRF + (RPM)b
= 5% + (7.5%)0.85
= 5% + 6.375%
= 11.375%.
5-17 Step 1: Determine the market risk premium from the CAPM:
0.12 = 0.0525 + (kM - kRF)1.25
(kM - kRF) = 0.054.
5-18 After additional investments are made, for the entire fund to have an
expected return of 13%, the portfolio must have a beta of 1.5455 as
shown below:
($20,000,0
00)(1.5) $5,000,000X
1.5455 = +
$25,000,00
0 $25,000,00
0
1.5455 = 1.2 + 0.2X
0.3455 = 0.2X
X = 1.7275.
c. Risk averter.
d. 1. ($1.15 million)(0.5) + ($0)(0.5) = $575,000, or an expected
profit of $75,000.
2. $75,000/$500,000 = 15%.
b. First, determine the fund’s beta, bF. The weights are the
percentage of funds invested in each stock.
A = $160/$500 = 0.32
B = $120/$500 = 0.24
C = $80/$500 = 0.16
D = $80/$500 = 0.16
E = $60/$500 = 0.12
kA kB Portfolio
1998 (18.00%) (14.50%) (16.25%)
1999 33.00 21.80 27.40
2000 15.00 30.50 22.75
2001 (0.50) (7.60) (4.05)
2002 27.00 26.30 26.65