Given
the returns and probabilities for the three possible states listed here,
calculate the covariance between the returns of Stock A and Stock B. For
convenience, assume that the expected returns of Stock A and Stock B are
0.10 and 0.15, respectively. (Round your answer to 4 decimal places.
For example .1244)
Probability
Return(A)
Return(B)
Good
0.35
0.30
0.50
OK
0.50
0.10
0.10
Poor
0.15
-0.25
-0.30
Answer:
0.0476
.png” alt=”ncorrect response”>
(0.0481)
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COV(RA,RB)=σAB=.35(.3-{A})(.5-{B}+(.5(.1-{A})(.1-{B})+.15(-.25-{A})(-.3-{B})
In
order to fund her retirement, Michele requires a portfolio with an expected
return of 0.10 per year over the next 30 years. She has decided to invest
in Stocks 1, 2, and 3, with 25 percent in Stock 1, 50 percent in Stock 2, and
25 percent in Stock 3. If Stocks 1 and 2 have expected returns of 0.09
and 0.09 per year, respectively, then what is the minimum expected annual
return for Stock 3 that will enable Michele to achieve her investment requirement?
Answer:
0.21
.png” alt=”ncorrect response”>
(0.13)
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The formula for the expected return of a three-stock
portfolio is:
E(R3assetport ) = x1E(R1)+
x2E(R2)+x3E(R3)
The
beta of M Simon Inc., stock is 1.8, whereas the risk-free rate of return
is 0.08. If the expected return on the market is 0.14, then what
is the expected return on M Simon Inc?
Answer:
0.076
.png” alt=”ncorrect response”>
(0.1880)
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SOLUTION:
E(RELSENORE) = Rrf+ β(E(Rm)
– Rrf)
Where Rrf=risk free rate, β = beta, and E(Rm)
= Expected return on the market
The risk-free rate of return is currently 0.03,
whereas the market risk premium is 0.06. If the beta of RKP, Inc., stock
is 1.6, then what is the expected return on RKP?
Answer:
0.11
.png” alt=”ncorrect response”>
(0.126)
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Feedback
SOLUTION:
E(Rlenz) = Rrf+ β(E(Rm)
– Rrf)
Where Rrf=risk free rate, β = beta, and E(Rm)
= Expected return on the market.
Note that the market premium is (E(Rm) –
Rrf)
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