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- Two investors are evaluating General Electric’s stock for possible purchase. They agree on the expected value of D1, and also on the expected future dividend growth rate. Further, they agree on the risk of the stock. However, one investor normally holds stocks for 2 years and the other normally holds stocks for 10 years. On the basis of the type of analysis done in this chapter, they should both be willing to pay the same price for General Electric’s stock. True or false? Explain.Ms. B has $1000 to invest. She is considering investing in the common stock of company M. In addition, Ms. B will either borrow or lend at the risk-free rate. Ms. B decide to invest $350 in common stock of company M and $650 placed in the risk- free asset. The relevant parameters are 1) What is the expected return? 2) What is the variance of the portfolio? 3) What is the standard deviation of the portfolio?You're considering purchasing Proctor and Gamble Stock. Suppose the risk-free interest rate is 5.0% and the stock market's expected return is 13.50%. Also, suppose that if the stock market's value rises by 1%, stock in Proctor and Gamble typically rises by 1%. a. What is the percentage of Proctor and Gamble's risk premium? c. What is the correct discount rate to use according to the Capital Asset Pricing Model (CAPM) when analyzing the present value of future cash flows from this stock?
- Suppose you are given the following inputs for the Fama-Frech-3-Factor model. Required Return for Stock i: bi=0.8, kRF=8%, the market risk premium is 6%, ci=-0.6, the expected value for the size factor is 5%, di=-0.4, and the expected value for the book-to-market factor is 4%. Task: Estimate the required rate of return of this asset using the Capital asset pricing model and compare it with the Fama-French-3-factor model.Assume that you are using the Capital Asset Pricing Model (CAPM) to find the expected return for a share of common stock. Your research shows the following: Beta = βi = 1.54 Risk free rate = Rf = 2.5% per year Market return = E(RM) = 6.5% per year Based on this information, answer the following: A. Based on the beta, how does the stock's risk compare to the market overall? On what do you base your answer? B. Based on the beta, how would you expect the stock's returns to react to a decrease in returns in the market overall? Why? C. According to the CAPM and the information given above, what is the expected return E(Ri) for this stock? D. If the required rate of return on this stock were 7% per year, would you invest? Why or why not?Which of the following statements is true? Select one of the options i. – iii.The future value of an investment (A) after two years with an annualcompound interest (i) isi. less than the future value of the investment (A) after two years withsimple interest (i)ii. equals to the future value of the investment (A) after two years withsimple interest (i)iii. greater than the future value of the investment (A) after two years withsimple interest (i).
- Suppose there are two investments A and B. Either investment A or B has a 4.5% chance of a loss of $15 million, a 2% chance of a loss of $2 million, and a 93.5% change of a profit of $2 million. The outcomes of these two investments are independent of each other. (a) What is the 95% VaR of investment A? How about investment B? (b) What is the 95% for a portfolio consisting of both investments A and B?(Hint: write out the probabilities of all possible portfolio outcomes.) (c) Is the summation of the 95% VaRs of the individual investments greater or smaller than the 95% VaR of the portfolio? If we measure the risk of an investment or portfolio using VaR, does this suggest that diversificationmust decrease risk? (Intuitively, putting A and B in a portfolio is a form of diversification.)Assume you are given the following information for firms A and B: A B D $1,563,400.00 $2,357,316.00 E $2,051,347.00 $1,257,431.00 Price $31.25 $31.25 i 13.52% 13.52% EBIT $97,347.00 $97,347.00 No taxes How do you replicate an investment in 79% of stock B by using stock A? What is the return of the replicating strategy?You are given the following payoff table showing the possible annual returns of three securities for the year 2019 under different economic conditions. You considering just a single-security investment. Higher Growth Likely Growth Lower Growth Savings Account 6 6 4 Bond 9 12 15 Stock 32 21 -5 Probability 0.20 0.60 ? Required: Explain the meaning of 32 and 12 in the payoff table. Which security would you consider for investment based on the expected return? Which security would you consider for investment based on risk? Advise on the optimum rational decision and explain why?
- WINNER plans to invest in one of two stocks, each of which requires the same initial investment. The estimated return (cash flow) of these investments for the next year depends on economic conditions and their respective possibilities. State of Economy Probability Rate of Return Stock A Stock B Boom 0.15 0.30 0.25 Normal 0.55 0.12 0.08 Recession 0.30 0.01 -0.05 i) Compute expected rate of return for each asset. ii) Compute variance and standard deviation of rate of return for each asset. iii) Which asset should they purchase?Assume for parts (a) to (h) that the Capital Asset Pricing Model holds. The marketportfolio has an expected return of 5%. Stock A’s return has a market beta of 1.5, anexpected value of 7% and a standard deviation of 10%. Stock B’s return has amarket beta of 0.5 and a standard deviation of 20%. The correlation between stockA’s and stock B’s return is 0.5.Required:a) Explain the term ‘capital asset pricing model.’b) What is the risk-free rate?c) What is the expected return on stock B?d) Draw a graph with expected return on the y-axis and beta on the x-axis. Indicate the approximate position of the risk-free asset, the market portfolio and stocks A and B on this graph. Draw the line, which connects these four points.e) Explain the term ‘Securities Market Line’, and what is the slope of the SML for this economy?f) Consider a portfolio with a weight of 50% in stock A and 50% in stock B. What are its variance and expected return?g) Where would under-priced and over-priced securities plot on…What is required return using the capital asset pricing model if a stock's beta is 1.2 and the individual, who expects the market to rise by 11.2%, can earn 4.4% invested in a risk-free Treasury Bill?
