Solution Manual for CFIN2 2nd Edition by Besley

To download the complete and accurate content document, go to:

https://testbankbell.com/download/solution-manual-for-cfin2-2nd-edition-by-besley/
Solution Manual for CFIN2 2nd Edition by Besley

Solutions

CHAPTER 8

8-1  $100,000   $50,000 

 new = 1.5  + 3.0  = 1.5(0.66667) + 3.0(0.33333) = 2.0
 $100,000 + $50,000   $100,000 + $50,000 

8-2 r = 5% + (12% - 5%)1.5 = 15.5%

8-3 r = 4% + (5%)2.0 = 14%

8-4 CVD = 8.0%/10.0% = 0.8

CVE = 24.0%/36% = 0.6667

Stock E has the lower coefficient of variation, so it has the lower relative risk.

8-5 Portfolio beta:

Investment Weight Beta Portfolio beta

(1) (2) (3) (4) = (2) x (3)

$ 400,000 0.40 1.5 0.6

500,000 0.50 2.0 1.0
100,000 0.10 4.0 0.4
$1,000,000 1.00 2.0

rp = rRF + (rM – rRF)(βp) = 3% + (10% – 3%)2.0 = 17%.

Alternative solution: First compute the return for each stock using the CAPM equation
[rRF + (rM – rRF)βj], and then compute the weighted average of these returns.

rRF = 3% and rM – rRF = 7%.

Investment Beta rj = rRF + (rM – rRF)βj Weight

$ 400,000 1.5 13.5% 0.40

500,000 2.0 17.0 0.50
100,000 4.0 31.0 0.10
Total $1,000,000 1.00

rp = 13.5%(0.40) + 17.0%(0.50) + 31.0%(0.10) = 17%.

8-6 a. r̂M = (0.3)(15%) + (0.4)(9%) + (0.3)(18%) = 13.5%.

r̂S = (0.3)(20%) + (0.4)(5%) + (0.3)(12%) = 11.6%.

b.  M = (0.3)(15 - 13.5 )2 + (0.4)(9 - 13.5 )2 + (0.3)(18 - 13.5 )2 = 14.85 = 3.85%

Visit TestBankBell.com to get complete for all chapters

Solutions

 S = (0.3)(20 - 11.6 )2 + (0.4)(5 - 11.6 )2 + (0.3)(12 - 11.6 )2 = 38.64 = 6.22%

c. 3.85%
CVM = = 0.29
13.5%
6.22%
CVS = = 0.54
11.6%

8-7 βold = 1.2; there are five stocks in the portfolio

If one stock with β = 2.0 is sold, then the portfolio’s beta would change

βportfolio = 1.2 = 0.2(β1) + 0.2(β2) + 0.2(β3) + 0.2(β4) + 0.2(2.0) = 0.2(∑β of four stocks) + 0.2(2.0)

0.2(∑β of four stocks) + 0.4 = 1.2

(∑β of four stocks) = 0.8/0.2 = 4.0

βnew = 0.2(∑β of four stocks) + 0.2(1.0) = 0.2(4.0) + 0.2(1.0) = 1.0

Alternative solution: The sum of the betas in the original portfolio must equal 6.0 = 1.2 x 5
stocks. If a stock with β = 2.0 is replaced by a stock with β = 1.0, the sum of the betas in the
new portfolio should be 5.0 = 6.0 – 2.0 + 1.0. βp = 5.0/5 = 1.0.

8-8 βold = 1.5; portfolio value = $400,000

βnew = 1.8; portfolio value = $300,000

Thus, we know that

βold = 1.5 = ($300,000/$400,000)(βnew) + ($100,000/$400,000)(βStock)

1.5 = (0.75)1.8 + (0.25)(βstock)

βstock = 6.0 – 5.4 = 0.6

This can be confirmed by computing the portfolio’s beta using this information:

βold = ($300,000/$400,000)1.8 + ($100,000/$400,000)0.6 = 1.5

8-9 We know that βR = 1.50, βS = 0.75, rM = 15%, rRF = 9%.

rj = rRF + (rM – rRF)βj = 9% + (15% - 9%)βj.

rR = 9% + 6%(1.50) = 18.0%
rS = 9% + 6%(0.75) = 13.5
4.5%

8-10 a. rX = rRF + (rM – rRF)βX = 9% + (14% – 9%)1.3 = 15.5%.

b. RPM = rM – rRF = 14% - 9% = 5%

2
 Solutions

(1) rRF increases to 10%; RPM does not change:

rX = rRF + (RPM)βX = 10% + (5%)1.3 = 16.5%.

rM = rRF + (RPM)βM = 10% + (5%)1.0 = 15.0%.

(2) rRF decreases to 8%; RPM does not change:

rX = rRF + (RPM)βX = 8% + (5%)1.3 = 14.5%.

rM = rRF + (RPM)βM = 8% + (5%)1.0 = 13.0%.

c. (1) rM increases to 16%; RPM = 16% – 9% = 7%

rX = rRF + (RPM)βX = 9% + (7%)1.3 = 18.1%.

(2) rM decreases to 13%; RPM = 13% – 9% = 4%

rX = rRF + (RPM)βX = 9% + (4%)1.3 = 14.2%.

1.0% +11.0% + 5.9% + 8.2% + ( −15.8%) +13.7% 24%

8-11 r= = = 4.0%
6 6

(1.0% − 4%)2 + (11.0% − 4%)2 + (5.9% − 4%)2 + (8.2% − 4%)2 + ( −15.8% − 4%)2 + (13.7% − 4%)2
s=
6 −1

565.38
= = 113.076 =10.63%
5

10.63%
CV = = 2.66
4.0%

8-12 a. r̂A = 0.2(30%) + 0.5(17%) + 0.3(-5%) = 6% + 8.5% + (-1.5%) = 13.0%

r̂P = 0.2(20%) + 0.5(12%) + 0.3(-2%) = 4% + 6% + (-0.6%) = 9.4%

r̂Z = 0.2(2%) + 0.5(9%) + 0.3(27%) = 0.4% + 4.5% + 8.1% = 13.0%

b. A = 0.2(30% −13%)2 + 0.5(17% −13%)2 + 0.3(−5%−13%)2

= 57.8 + 8.0 + 97.2 = 163.0 =12.77%

P = 0.2(20% − 9.4%)2 + 0.5(12% − 9.4%)2 + 0.3( −2% − 9.4%)2

= 22.472 + 3.38 + 38.988 = 64.84 = 8.05%

Solution Manual for CFIN2 2nd Edition by Besley

Solutions
Z = 0.2(2% −13%)2 + 0.5(9% −13%)2 + 0.3(27% −13%)2

= 24.2 + 8.0 + 58.8 = 91.0 = 9.54%

c. CVA = 12.77%/13.0% = 0.98

CVP = 8.05%/9.4% = 0.86

CVZ = 9.54%/13.0% = 0.73

d. Investment Z has the lowest coefficient of variation, so it provides the best risk/return
relationship—that is, the lowest risk per unit of return.

e. Investment A and Investment Z appear to be negatively correlated, so it would be best to

pair these two investments. In fact, the correlation coefficient for the return on these two
investments is -0.99, which is close to perfect negative correlation. Is these investment are
combined 50/50 in a portfolio, the portfolio’s expected return will be 13 percent (the same
as the two individual investments) and its standard deviation will be 1.73 percent (much
lower than either of the two investments).

8-13 a. Following are the required rates of return for the stocks if RPM = 7%:

Stock Return
Ford 19.5% = 2% + (7%)2.5
General Mills 3.4% = 2% + (7%)0.2
Microsoft 9.0% = 2% + (7%)1.0
Wells Fargo 11.8% = 2% + (7%)1.4

b. Following are the required rates of return for the stocks if RPM = 5%:

Stock Return
Ford 14.5% = 2% + (5%)2.5
General Mills 3.0% = 2% + (5%)0.2
Microsoft 7.0% = 2% + (5%)1.0
Wells Fargo 9.0% = 2% + (5%)1.4

c. When the market risk premium changes, the amount by which the required return on an
individual stock changes equals the market risk premium times the stock’s beta
coefficient—that is, the change in the stock return = ΔRPM(βStock). As a result, stocks with
higher betas will experience greater changes in their required rates of return when the
market’s risk premium changes by a particular amount.

Visit TestBankBell.com to get complete for all chapters