Ch 6 problems (1)

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Florida International University *

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Chemistry

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Dec 6, 2023

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Ch 6 problems: Required Rate of Return As an equity analyst you are concerned with what will happen to the required return to Universal Toddler Industries’s stock as market conditions change. Suppose rRF = 5%, rM = 12%, and bUTI = 1.4. a. Under current conditions, what is rUTI, the required rate of return on UTI stock? b. Now suppose rRF (1) increases to 6% or (2) decreases to 4%. The slope of the SML remains constant. How would this affect rM and rUTI? c. Now assume rRF remains at 5% but rM (1) increases to 14% or (2) falls to 11%. The slope of the SML does not remain constant. How would these changes affect rUTI? (1) increases to 14% or (2) falls to 11%. The slope of the SML does not remain constant. How would these changes affect rUTI? Solution: a. Ri = Rrf + (Rm – Rrf)Bi 14.8% =5% + (12% - 5%)1.4 b. 1. Rm increases by 1% point 15.8% =6% +(13% -6%)1.4 2. Rm decreases by 1% point 13.8% =4% +(11% -4%)1.4 c. 1. rM increases to 14%: ri = rRF + (rM - rRF)bi = 5% + (14% - 5%)1.4 = 17.6%. 2. rM decreases to 11%: ri = rRF + (rM - rRF)bi = 5% + (11% - 5%)1.4 = 13.4% Portfolio Beta Your retirement fund consists of a $5,000 investment in each of 15 different common stocks. The portfolio’s beta is 1.20. Suppose you sell one of the stocks with a beta of 0.8 for $5,000 and use the proceeds to buy another stock whose beta is 1.6. Calculate your portfolio’s new beta Solution: N(BP) = Bp - Bs * IS/TI +Bb * IB/TI **N(Bp)= Portfolio’s new beta, Bp= Old Beta, Bs- Beta of stock sold, IS= Investment in stock sold, TI= Total investment, Bb= Beta of stock bought, IB= Investment in stock bought, TI= Total investment 1.25 = 1.2 - .8 * 5,000/15*5,000 + 1.6 * 5000/15*5000
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