Calculating the expected return for stock


PROBLEM 1:

The returns of Stock A and Stock B have the following distribution:

Demand for the

Company's Products

Probability of this

Demand Occurring

Rate of Return

Stock A

Rate of Return

Stock B

Weak

15.0%

(18.0%)

(24.0%)

Below Average

25.0%

(22.0%)

(4.0%)

Average

20.0%

44.0%

24.0%

Above Average

30.0%

22.0%

8.0%

Strong

10.0%

34.0%

56.0%

 

100.0%

 

 

a) Calculate the Expected Return for Stock A and Stock B

b) Calculate the Variance and the Standard Deviation for Stock A and Stock B

c) Calculate the Coefficient of Variation of each stock

d) Calculate the Correlation Coefficient between Stock A and Stock B

e) In which of the two stocks would you invest your money? Explain.

PROBLEM 2:

You have observed the following returns over time:

Year

Stock X

Stock Y

Stock Z

Market

2000

14%

13%

(18%)

12%

2001

19%

7%

33%

10%

2002

(16%)

(5%)

15%

(12%)

2003

3%

1%

(4%)

1%

2004

20%

11%

27%

15%


Assume that the risk-free rate is 6% and the market risk premium is 5%

a) What are the betas of Stocks X, Y and Z?

b) What are the required rates of return for Stocks X, Y and Z?

c) What are the standard deviations for Stocks X, Y and Z?

d) What is the required rate of return and standard deviation for a portfolio consisting of 20% invested in Stock X, 45% invested in Stock Y, and 35% invested in Stock Z?

e) If Stock X’s expected return is 22%, is Stock X under-or-over valued?

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Finance Basics: Calculating the expected return for stock
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