Problem 1. (Expected rate of return and risk) Summerville Inc. is considering an investment in one of two common stocks. Given the information that follows, which investment is better, based on the risk (as measured by the standard deviation) and return of each?
COMMON STOCK A COMMON STOCK B
PROBABILITY RETURN PROBABILY RETURN
.30 11% .20 -5%
.40 15% .30 6%
.30 19% .30 14%
.20 22%
Problem 2. (Required rate of return using CAPM)
a. Compute a fair rate of return for Intel common stock, which has a 1.2 beta. The risk-free rate is 6 percent.
b. Why is the rate you computed a fair rate?
Problem 3. (Capital asset pricing model) Levine Manufacturing Inc. is considering several investments. The rate on Treasury bills is currently 6.75 percent, and the expected return for the market is 12 percent. What should be the required rates of return for each investment (using the CAPM)?
Problem 4. (Capital asset pricing model) MFI Inc. has a beta of .86. If the expected market return is 11.5 percent and the risk-free rate is 7.5 percent, what is the appropriate required return of MFI (using the CAPM)?