Mini Test 4 – K19404C

18/4/2021
Question 1:
There are two assets and three states of the economy:

State of Probability of Rate of Return If State Occurs

Economy State of Economy Stock A Stock B
Recession 0.20 -0.15 0.20
Normal 0.50 0.20 0.30
Boom 0.30 0.60 0.40

What are the expected returns and standard deviations for these two stocks?
Using the information in the previous problem, suppose you have $20,000 total. If you put
$15,000 in Stock A and the remainder in Stock B, what will be the expected return and
standard deviation of your portfolio?
Question 2:
The risk-free rate is 3%, and the market risk premium rM–rRF is 4%. Stock A has a beta of
1.2, and Stock B has a beta of 0.8.
a. What is the required rate of return on each stock?
b. Assume that investors become less willing to take on risk (i.e., they become more risk
averse), so the market risk premium rises from 4% to 6%. Assume that the risk-free rate
remains constant. What effect will this have on the required rates of return on the two stocks?
Question 3:
Suppose the risk-free rate is 8 percent. The expected return on the market is 16 percent. If a
particular stock has a beta of 0.7, what is its expected return based on the CAPM? If another
stock has an expected return of 24 percent, what must its beta be?
Question 4:
Suppose you are the money manager of a $4 million investment fund. The fund consists of
four stocks with the following investments and betas:

Stock Investment Beta

A 400,000 1.50
B 600,000 (0.50)
C 1,000,000 1.25
D 2,000,000 0.75

If the market’s required rate of return is 14% and the risk-free rate is 6%, what is the fund’s
required rate of return?