Chapter 11, Problem 29QAP

a

Summary Introduction

Adequate information:

Expected return for Firm A $\left({\text{ER}}_{\text{A}}\right)$ = 0.10

Expected return for Firm B $\left({\text{ER}}_{\text{B}}\right)$ = 0.14

Expected return for Firm C $\left({\text{ER}}_{\text{C}}\right)$ = 0.16

Expected return on market portfolio $\left({\text{ER}}_{\text{P}}\right)$ = 0.12

Expected return for risk-free asset $\left({\text{ER}}_{\text{Rf}}\right)$ = 0.05

Standard deviation of Firm A $\left({\sigma }_{\text{A}}\right)$ = 0.31

Standard deviation of Firm C $\left({\sigma }_{\text{C}}\right)$ = 0.65

Standard deviation on market portfolio $\left({\sigma }_{\text{P}}\right)$ = 0.20

Correlation of Firm B $\left({\text{ρ}}_{\text{B}}\right)$ = 0.50

Correlation of Firm C $\left({\text{ρ}}_{\text{C}}\right)$ = 0.35

Beta of Firm A $\left({\text{β}}_{\text{A}}\right)$ = 0.85

Beta of Firm B $\left({\text{β}}_{\text{B}}\right)$ = 1.40

To compute: Standard deviation, correlation, and beta on the portfolio.

Introduction: Standard deviation of the portfolio refers to the deviation of the actual returns from the expected returns. Correlation refers to the degree of fluctuation of two variables in relation to one another. Beta refers to the systematic risk on the entire investment portfolio.

b

Summary Introduction

Adequate information:

Firm A stock is correctly priced

Firm B and C stocks are incorrectly priced

To compute: Investment recommendation

Introduction: Expected return refers to the returns that are expected on the investment.