You hold a fully diversified portfolio of stocks and are considering investing in the XYZ Company. The firm's prospects look good and you estimate the following probability distribution of possible returns:
Probability ----------------------- Return
70% -------------------------------- 15%
20% -------------------------------- 9%
10% -------------------------------- 20%
The return on the market is 13.5% and the risk free rate is 7%. You have calculated XYZ's beta from past returns as 1.3 and you believe this will be the future beta.
1. What is the expected return for XYZ?
A) 14.30%
B) 14.67%
C) 33.33%
D) 13.50%
2. What is the required return for XYZ according to the CAPM?
A) 8.45%
B) 13.50%
C) 15.45%
D) 24.55%
3. If the standard deviation of XYZ's distribution of possible returns is 3.03%, what is the coefficient of variation?
A) 3.03%
B) 4.72%
C) 14.3%
D) 21.2%
4. What is the excess return required for this stock?
A) 6.5%
B) 7%
C) 8.45%
D) 1.95%
5. Based on the information and calculations in the three questions above, should you buy stock in XYZ Company?
A) Yes
B) No