Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
4th Edition
ISBN: 9780134083278
Author: Jonathan Berk, Peter DeMarzo
Publisher: PEARSON
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Chapter 11, Problem 28P
Consider the portfolio in Problem 27. Suppose the correlation between Intel and Oracle’s stock increases, but nothing else charges. Would the portfolio be more or less risky with this change?
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Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?
a. The required return on a stock with beta = 1.0 will not change.
b. The required return on a stock with beta > 1.0 will increase.
c. The return on "the market" will increase.
d. The return on "the market" will remain constant.
e. The required return on a stock with a positive beta < 1.0 will decline.
Suppose you observe the following situation:Security Beta Expected ReturnDiamond Co 1.3 0.2Spade Co 0.8 0.14 (a) According to the above information, could we figure out the market return and risk-free rate? Explain your answer. (b) Discuss the possibility of including zero beta or negative beta assets in your portfolio. Explain the pros and cons of including these types of assets.
Consider the following portfolio choice problem. The investor has initial wealth w andutility u(x) = (x^n) /n. There is a safe asset (such as a US government bond) that has netreal return of zero. There is also a risky asset with a random net return that has onlytwo possible returns, R1 with probability 1 − q and R0 with probability q. We assumeR1 < 0, R0 > 0. Let A be the amount invested in the risky asset, so that w − A isinvested in the safe asset.i) What are risk preferences of this investor, are they risk-averse, riskneutral or risk-loving?ii) Find A as a function of w.
Chapter 11 Solutions
Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
Ch. 11.1 - What is a portfolio weight?Ch. 11.1 - How do we calculate the return on a portfolio?Ch. 11.2 - What does the correlation measure?Ch. 11.2 - How does the correlation between the stocks in a...Ch. 11.3 - Prob. 1CCCh. 11.3 - Prob. 2CCCh. 11.4 - Prob. 1CCCh. 11.4 - Prob. 2CCCh. 11.4 - Prob. 3CCCh. 11.5 - What do we know about the Sharpe ratio of the...
Ch. 11.5 - If investors are holding optimal portfolios, how...Ch. 11.6 - When will a new investment improve the Sharpe...Ch. 11.6 - Prob. 2CCCh. 11.7 - Prob. 1CCCh. 11.7 - Prob. 2CCCh. 11.8 - Prob. 1CCCh. 11.8 - According to the CAPM, how can we determine a...Ch. 11 - You are considering how to invest part of your...Ch. 11 - You own three stocks: 600 shares of Apple...Ch. 11 - Consider a world that only consists of the three...Ch. 11 - There are two ways to calculate the expected...Ch. 11 - Using the data in the following table, estimate...Ch. 11 - Use the data in Problem 5, consider a portfolio...Ch. 11 - Using your estimates from Problem 5, calculate the...Ch. 11 - Prob. 8PCh. 11 - Suppose two stocks have a correlation of 1. If the...Ch. 11 - Arbor Systems and Gencore stocks both have a...Ch. 11 - Prob. 11PCh. 11 - Suppose Avon and Nova stocks have volatilities of...Ch. 11 - Prob. 13PCh. 11 - Prob. 14PCh. 11 - Prob. 16PCh. 11 - What is the volatility (standard deviation) of an...Ch. 11 - Prob. 18PCh. 11 - Prob. 19PCh. 11 - Prob. 20PCh. 11 - Suppose Ford Motor stock has an expected return of...Ch. 11 - Prob. 22PCh. 11 - Prob. 23PCh. 11 - Prob. 24PCh. 11 - Prob. 25PCh. 11 - Prob. 26PCh. 11 - A hedge fund has created a portfolio using just...Ch. 11 - Consider the portfolio in Problem 27. Suppose the...Ch. 11 - Prob. 29PCh. 11 - Prob. 30PCh. 11 - You have 10,000 to invest. You decide to invest...Ch. 11 - Prob. 32PCh. 11 - Prob. 33PCh. 11 - Prob. 34PCh. 11 - Prob. 35PCh. 11 - Prob. 36PCh. 11 - Assume all investors want to hold a portfolio...Ch. 11 - In addition to risk-free securities, you are...Ch. 11 - You have noticed a market investment opportunity...Ch. 11 - Prob. 40PCh. 11 - When the CAPM correctly prices risk, the market...Ch. 11 - Prob. 45PCh. 11 - Your investment portfolio consists of 15,000...Ch. 11 - Suppose you group all the stocks in the world into...Ch. 11 - Prob. 48PCh. 11 - Consider a portfolio consisting of the following...Ch. 11 - Prob. 50PCh. 11 - What is the risk premium of a zero-beta stock?...
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- Consider the following portfolio choice problem. The investor has initial wealth w and utility u(x) = −e. There is a safe asset (such as a US government bond) that has net real return of zero. There is also a risky asset with a random net return that has only two possible returns, R₁ with probability 1 − q and Ro with probability q. We assume R₁ ≤ 0, Ro > 0. Let a be the share of wealth w invested in the risky asset, so that 1 – a share of wealth is invested in the safe asset. (a) Find a as a function of w. How does a change with wealth? Explain the intuition.arrow_forwardIs the following statement true or false? Explain your answer. As more securities are added to a portfolio, total risk is generally expected to fall, and fall at a decreasing rate as the number (n) of securities added increases.arrow_forwardThe market portfolio (M) has the expected rate of return E(rM) = 0.12. Security A is traded in the market. We know that E(rA) = 0.17 and βA = 1.5. (1) What is the rate of return of the risk-free asset (rf)? (2) Security B is also traded in the market. βB = 0.8. Then what is “fair” expected rate of return of security B according to the CAPM? (3) Security C is a third security traded in the market. βC = 0.6, and from the market price, investors calculate E(rC) = 0.1. Is C overpriced or underpriced? What is αC?arrow_forward
- Assume that the CAPM assumptions hold. Consider the following statements:i. A stock with a beta below zero will tend to move in the same direction as the market but will tend to move less aggressively in that direction than the market does.ii. Alpha measures the additional risk we take on top of the risk of the market portfolio.arrow_forwardSuppose that stocks are exposed to systematic risks only so that stock i has the following return structure: Ri,t = mį + Si,t where mi is the average return, and si,t is the systematic risk. When we construct a portfolio including more and more stocks, which of the following would happen? The portfolio volatility gradually decreases and eventually converges to a certain positive value. ● The portfolio volatility gradually decreases and eventually converges to zero. The portfolio volatility stays unchanged.arrow_forwardConsider the following portfolio choice problem. The investor has initial wealth w and utility u(x)=. There is a safe asset (such as a US government bond) that has net real return of zero. There is also a risky asset with a random net return that has only two possible returns, R₁ with probability 1-q and Ro with probability q. We assume R₁ 0. Let A be the amount invested in the risky asset, so that w - A is invested in the safe asset. 1) Does the investor put more or less of his portfolio into the risky asset as his wealth increases?arrow_forward
- A4) Critically explain the risk premium of a zero-beta stock. Does this mean you can lower the volatility of a portfolio without changing the expected return by substituting out any zero-beta stock in a portfolio and replacing it with the risk-free asset?arrow_forwardIf a change in the investment environment leads to a decrease in the Risk-Free Rate while the Return on the Market Portfolio remains constant, then: The Expected Return on Low Beta Stocks should increase. The Expected Return on Low Beta Stocks should decrease. The Expected Return on Low Beta Stocks should remain unchanged. Cannot be determined. None of the above answers is correct. Page 8 of 9 If a change in the investment environment leads to a decrease in the Risk-Free Rate while the Return on the Market Portfolio remains constant, then: The Expected Return on High Beta Stocks should increase. The Expected Return on High Beta Stocks should decrease. The Expected Return on High Beta Stocks should remain unchanged. Cannot be determined. None of the above answers is correct.arrow_forward(a) Determine the expected return of security X (b) To reduce the systematic risk of the portfolio, Anna is considering 3 securities to add to the portfolio. Security A has a beta of 0, security B has a beta of 0.5 and Security C has a beta of -0.3. Discuss which security will be most effective in reducing the portfolio’s systematic risk? How would portfolio expected return change (higher or lower) if you add this security?arrow_forward
- 9. Suppose you plan to form your overall investment portfolio in two steps: STEP 1: Choose a portfolio of stocks with a zero position in the risk-free asset. STEP 2: Allocate your money between the portfolio from Step 1 and the risk-free asset. Suppose you can borrow and lend as much as you want at the risk-free rate in Step 2. Let Erp be the expected return of the Step 1 portfolio. Let Var(rp) be the variance of the return of the Step 1 portfolio. Let rf be the risk-free rate. How will you form the Step 1 Portfolio? Set the Step 1 portfolio to maximize Erp SettheStep1portfoliotominimizeVar(rp) Set the Step 1 portfolio to maximize Erp - Var(rp) Set the Step 1 portfolio to maximize the ratio Erp/Var(rp) Set the Step 1 portfolio to maximize the ratio (Erp- rf)/Var(rp) None of the above.arrow_forwardSuppose our portfolio consists of two stocks A and B. What should be the correlation between them so that we have no risk in our portfolio?arrow_forwardThe SML shows the return needed given risk as measured by beta. And there are situations where a stock might be mispriced relative to CAPM. Given the relationship with the security mark line (SML), if a stock is properly priced relative to CAPM , where would it plot on the graph relative to the SML? A. on the Y-axis B. on the security market line C. below the security market line D. above the security market linearrow_forward
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