3. Consider the information in the table below for Stocks A, B, and C. The returns on the three stocks are positively correlated, but they are not perfectly correlated. (That is, each of the correlation coefficients is between 0 and 1). Fund P has one-third of its funds invested in each of the three stocks. The risk-free rate is 5.5%, and the market is in equilibrium. (That is, required returns equal expected returns.) What is the market risk premium? What is the beta of Fund P? What is the required return of Fund P? Would you expect the standard deviation of Fund P to be less than 15%, equal to 15%, or greater than 15%? Stock ABC Expected Return Standard Deviation Beta 9.55% 10.45% 12.70% 15% 15% 15% 0.9 1.1 1.6
3. Consider the information in the table below for Stocks A, B, and C. The returns on the three stocks are positively correlated, but they are not perfectly correlated. (That is, each of the correlation coefficients is between 0 and 1). Fund P has one-third of its funds invested in each of the three stocks. The risk-free rate is 5.5%, and the market is in equilibrium. (That is, required returns equal expected returns.) What is the market risk premium? What is the beta of Fund P? What is the required return of Fund P? Would you expect the standard deviation of Fund P to be less than 15%, equal to 15%, or greater than 15%? Stock ABC Expected Return Standard Deviation Beta 9.55% 10.45% 12.70% 15% 15% 15% 0.9 1.1 1.6
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:**Understanding Stock Portfolio Risks and Returns**
Consider the following information on three stocks, A, B, and C. The returns on these stocks are positively correlated, yet not perfectly so. This implies that although the stocks tend to move in the same direction, they do not move in perfect harmony (this is based on the correlation coefficients which lie between 0 and 1).
**Investment Fund P** has one-third of its funds invested equally in each of these three stocks. The risk-free rate is set at 5.5%, and the market is in equilibrium, which means the expected returns are equal to the required returns.
**Analysis Questions:**
1. What is the market risk premium?
2. What is the beta of Fund P?
3. What is the required return of Fund P?
4. Is the standard deviation of Fund P expected to be less than, equal to, or greater than 15%?
**Table Overview:**
| Stock | Expected Return | Standard Deviation | Beta |
|-------|-----------------|--------------------|------|
| A | 9.55% | 15% | 0.9 |
| B | 10.45% | 15% | 1.1 |
| C | 12.70% | 15% | 1.6 |
- **Expected Return**: This represents the average return anticipated on the stock.
- **Standard Deviation**: This shows the extent to which the return on the stock is expected to vary.
- **Beta**: A measure of the stock's volatility in relation to the market. A beta higher than 1 indicates that the stock is more volatile than the market, whereas a beta less than 1 indicates lower volatility.
These components are crucial for evaluating the risk and potential return of investments in these stocks and for constructing an efficient, diversified portfolio.
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