1. Portfolio Expected Return. You have $10,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 14 percent and Stock Y with an expected return of 11 percent. If your goal is to create a portfolio with an expected return of 12.4 percent, how much money will you invest in Stock X? In Stock Y?
2. Calculating Returns and Standard Deviations. Based on the following information, calculate the expected return and standard deviation for the two stocks.
3. Using CAPM. A stock has a beta of 1.15 and an expected return of 10.4 percent. A risk-free asset currently earns 3.8 percent.
a. What is the expected return on a portfolio that is equally invested in the two assets?
b. If a portfolio of the two assets has a beta of .7, what are the portfolio weights?
c. If a portfolio of the two assets has an expected return of 9 percent, what is its beta?
d. If a portfolio of the two assets has a beta of 2.3, what are the portfolio weights? How do you interpret the weights for the two assets in this case? Explain.
4. SML Suppose you observe the following situation:
a. Calculate the expected return on each stock.
b. Assuming the capital asset pricing model holds and stock A's beta is greater than stock B's beta by .25, what is the expected market risk premium?
EXCEL FILE 2 Critical Thinking Problems:
5. Systematic versus Unsystematic Risk. Classify the following events as mostly systematic or mostly unsystematic. Is the distinction clear in every case?
a. Short-term interest rates increase unexpectedly.
b. The interest rate a company pays on its short-term debt borrowing is increased by its bank.
c. Oil prices unexpectedly decline.
d. An oil tanker ruptures, creating a large oil spill.
e. A manufacturer loses a multimillion-dollar product liability suit.
f. A Supreme Court decision substantially broadens producer liability for injuries suffered by product users.
6. Systematic versus Unsystematic Risk. Indicate whether the following events might cause stocks in general to change price, and whether they might cause Big Widget Corp.'s stock to change price.
a. The government announces that inflation unexpectedly jumped by 2 percent last month.
b. Big Widget's quarterly earnings report, just issued, generally fell in line with analysts' expectations.
c. The government reports that economic growth last year was 3 percent, which generally agreed with most economists' forecasts.
d. The directors of Big Widget die in a plane crash.
e. Congress approves changes to the tax code that will increase the top marginal corporate tax rate. The legislation had been debated for the previous six months.