Assume that using the Security Market Line (SML) the required rate of return (RA) on stock A is found to be half of the required return (RB) on stock B. The risk-free rate (Rf) is one-fourth of the required return on A. Return on market portfolio is denoted by RM. Find the ratio of beta of A (A) to beta of B (B).
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Assume that using the Security Market Line (SML) the required
to be half of the required return (RB) on stock B. The risk-free rate (Rf) is one-fourth of the required
return on A. Return on market portfolio is denoted by RM. Find the ratio of beta of A (A) to beta of B
(B).
d) Assume that the short-term risk-free rate is 3%, the market index S&P500 is expected to pay
returns of 15% with the standard deviation equal to 20%. Asset A pays on average 5%, has standard
deviation equal to 20% and is NOT correlated with the S&P500. Asset B pays on average 8%, also has
standard deviation equal to 20% and has correlation of 0.5 with the S&P500. Determine whether
asset A and B are overvalued or undervalued, and explain why.
(Hint: Beta of asset i (??) =
?????
??
, where ??
,?? are standard deviations of asset i and market
portfolio, ??? is the correlation between asset i and the market portfolio)
Question 2. Foreign exchange markets
Statoil, the national company in Norway, is a large, sophisticated, and active participant in both the
currency and petrochemical markets. Although it is a Norwegian company, because it operates within
the global oil market, it considers the U.S. dollar ($), rather than the Norwegian krone (Nok), as its
functional currency. Ari Karlsen is a currency trading strategist for Statoil. Answer the following two
independent questions a) and b):
a) Statoil sold 1 million barrels of crude oil to the Norwegian petrol station chain, Circle K, today
for 120 Nok per barrel (Nok denotes the Norwegian Krone). Statoil expects to receive the full
payments from Circle K in 3 months’ time when the crude oil is delivered to Circle K’s facilities
in Norway. Statoil is informed that Circle K will pay for the oil in Norwegian Krone. Ari is asked
by the Chief Financial Officer (CFO) about the strategy to reduce the uncertainty around the
expected payment from Circle K. Ari is faced with the following market rates:
Spot exchange Rate Nok 6.0312/$
3-month forward rate Nok 6.0186/$
U.S. dollar 3-month interest rate 5%
Norwegian Krone 3-month interest rate 4.45%
Based on the above information, what hedging strategy should Ari advise the CFO that works the best
for Statoil? Explain why Ari should choose such hedging strategy. How much U.S. dollar will Statoil
receive at the end of 3 months by using this hedging strategy?
Trending now
This is a popular solution!
Step by step
Solved in 4 steps with 5 images
