Intermediate Financial Management
14th Edition
ISBN: 9780357516782
Author: Brigham, Eugene F., Daves, Phillip R.
Publisher: Cengage Learning
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Chapter 2, Problem 14MC
Summary Introduction
Case summary:
Person X is a graduate, who is working as a financial planner at company C. The president and congress involved in the dispute of acrimonious over the financing of debt and budget. The dispute which is not settled at the end of the year and effected the rate of interest.
The responsibility of person X is to compute the risk of bond portfolio of client. Person X should explain the probable scenarios for the dispute resolution and compute
To discuss: The impact of higher rate of interest on security market line and returns needed on less risk and high risk securities, if risk free rate increases to 7%.
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Suppose the risk-free rate goes up to 7%.What effect would higher interest rates have onthe SML and on the returns required on highrisk and low-risk securities? (2) Suppose insteadthat investors’ risk aversion increased enoughto cause the market risk premium to increase to8%. (Assume the risk-free rate remains constant.)What effect would this have on the SML and onreturns of high- and low-risk securities?
Is 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.
True or false: Assume that expected returns and standard deviations for all securities (including the risk-free rate for borrowing and lending) are known. In this case, all investors will have the same optimal risky portfolio.
Chapter 2 Solutions
Intermediate Financial Management
Ch. 2 - Prob. 2QCh. 2 - Security A has an expected return of 7%, a...Ch. 2 - Prob. 4QCh. 2 - Prob. 5QCh. 2 - Your investment club has only two stocks in its...Ch. 2 - AA Corporations stock has a beta of 0.8. The...Ch. 2 - Suppose that the risk-free rate is 5% and that the...Ch. 2 - Prob. 5PCh. 2 - The market and Stock J have the following...Ch. 2 - Prob. 7P
Ch. 2 - Prob. 8PCh. 2 - Prob. 9PCh. 2 - Prob. 10PCh. 2 - Prob. 11PCh. 2 - Stock R has a beta of 1.5, Stock S has a beta of...Ch. 2 - Prob. 1MCCh. 2 - Prob. 2MCCh. 2 - Prob. 3MCCh. 2 - What is the stand-alone risk? Use the scenario...Ch. 2 - Prob. 5MCCh. 2 - Prob. 6MCCh. 2 - Prob. 7MCCh. 2 - Prob. 8MCCh. 2 - Prob. 9MCCh. 2 - Prob. 10MCCh. 2 - Prob. 11MCCh. 2 - Prob. 12MCCh. 2 - Prob. 13MCCh. 2 - Prob. 14MCCh. 2 - Prob. 15MCCh. 2 - Prob. 16MCCh. 2 - Prob. 17MCCh. 2 - Prob. 18MC
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- Given that the formula for CAPM is Expected return= risk free rate + Beta*(Return on market - risk free rate), Security A has a beta of 1.16 and an expected return of .1137 and Security B has a beta of .92 and expected return of .0984. If these securities are assumed to be correctly priced, what is their risk free rate? Based on CAPM, what is the return on the market?arrow_forwardSuppose you observe the following situation on two securities:Security Beta Expected Return Pete Corp. 0.8 0.12 Repete Corp. 1.1 0.16 Assume these two securities are correctly priced. Based on the CAPM, what is the return on the market?arrow_forwardDo solve all parts A. What risk premium do you use? Why? B. Why is the geometric mean lower than the arithmetic mean for both bonds and bills? C. If you had to use a risk premium with the longer periods, what biases will the investor have?arrow_forward
- Suppose you observe the following situation: Security Beta Expected Return Peat Company 1.70 13.60 Re - Peat Company 0.85 10.80 Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk - free rate?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_forwardConsider the following scenario analysis A. Is it reasonable to assume that treasury bonds will provide higher returns in recessions than in booms? B. Calculate the expected rate of return and standard deviation for each investment. C. What investment would you prefer?arrow_forward
- A reduction in the willingness of investors to take on risk would have what effect on the Security Market Line? A.no effect B.rotate the SML counter clockwise around the risk-free rate C.rotate the SML clockwise around the risk-free rate D.shift the SML upward, parallel to its previous locationarrow_forwardAssume 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.arrow_forwarda) Suppose the risk-free rate is 7% and the expected rate of return on the market portfolio is 10%. In your view, the expected rate of return of a security is 12.2%. Given that this security has a beta of 1.4, do you consider it to be overpriced, under-priced or fairly priced according to the Capital Asset Pricing Model? Please provide the details of your calculations b) explain when a security is overpriced, under-priced or fairly priced according to the Capital Asset Pricing Model.arrow_forward
- You have also decided that you have a risk-aversion (A) of 4.(a) What is the expected return for each of the securities?(b) What is the volatility of each security return?(c) What is the covariance between stock and bond returns?(d) If you combine stocks and bills as an investment, what is your optimal combination? What is your expected return? What is yourportfolio’s volatility?(e) If you combine bonds and bills, what is your optimal combination?What is your expected return? What is your portfolio’s volatility?(f) If you combine stocks and bonds, what is your optimal combination?What is your expected return? What is your portfolio’s volatility?(g) If you combine all three assets in your portfolio, what is your optimal combination? What is your expected return? What is yourportfolio’s volatility?arrow_forwardAssess the following statement: 1. If investors were indifferent to maturities, the return of any security should equal the compounded yield of consecutive investments in shorter-term securities. II. The forward rate is sometimes used as an approximation of the market's consensus interest rate forecast. The reason is that, if the market had a different perception, the demand and supply of today's existing two-year and one-year securities would adjust to capitalize on this information. III. According to pure expectations theory, the term structure of interest rates is determined solely by expectations of interest rates. O Only one statement is correct. All statements are correct. O No answer text provided. O Only one statement is incorrect.arrow_forwardIf the yield curve in the bond market shows a flat curve, what do you think about the prediction of the liquidity premium in explaining this phenomenon? Then do you prefer the prediction of expectation theory in explaining this phenomenon?arrow_forward
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