EBK CFIN
6th Edition
ISBN: 9781337671743
Author: BESLEY
Publisher: CENGAGE LEARNING - CONSIGNMENT
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Chapter 8, Problem 18PROB
Summary Introduction
Portfolio beta is used to measure the portfolio’s overall systematic risk of an investment which equals the weighted average of all individual stock’s beta coefficient in a portfolio.
Here,
The cost of equity or required rate of return is “r”.
The risk-free rate is “
The risk premium is “
The market return is “
The beta coefficient is “
The required rate of return of stock Q is 11%, risk-free rate is 4%, and market return is 9%. As per new information, the market risk premium increase by 1%.
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Karen Kay, a portfolio manager at Collins Asset Management, is using thecapital asset pricing model (CAPM) for making recommendations to her clients.Her research department has developed the information shown in the followingexhibit.Forecast Returns, Standard Deviations, and BetasForecast Return Standard Deviation BetaLow β stock (X) 14.0% 36% 0.8High β stock (Y) 17.0% 25% 1.5Market index 14.0% 15% 1.0Risk-free rate 5.0%(a) Calculate expected return and alpha for each stock.(b) Identify and justify which stock would be more appropriate for an investorwho wants to add this stock to a well-diversified equity portfolio.(c) Now consider Karen employs the “Betting Against Beta” strategy and let, , and denote the portfolio weights of the investmentin each of the asset classes (e.g. risk-free asset, low beta stock, market index,high beta stock, respectively) such that .According to its investment mandate, Collins Asset Management shouldtarget a gross leverage of 2.3. How much does she have to…
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