Fuqua Business School

Duke University
FIN 350
Global Financial Management
Practice Questions
(CAPM)
1. These practice questions are a suplement to the problem sets, and are intended for those of
you who want more practice. They are Optional, and are not part of the required
material.
2. It is recommended that you look at these problems only after you fully understand how to
solve the problem sets, the examples we covered in class, and the ones in the lecture notes.
3. Please note that I have collected these exmples from previous teaching material
I have had. As such, while in most cases the notation will match the one used in
class, the match is not 100%.
4. Some of these questions are easier than the ones you are expected to know how to solve, while
others are above the level of knowledge you are expected to show on quizes and the nal.
ENJOY!
FIN 350 Practice Questions 2
1. The Alpha rm makes pneumatic equipment. Its beta is 1.2. The market risk premium is
8.5%, and the current risk-free rate is 6%. What is the expected return for the Alpha rm?
2. Suppose the market risk premium is 7.5 percent and the risk-free rate is 3.7 percent. The
expected return of Textile Industries is 14.2 percent. What is the beta for Textile Industries?
3. Suppose that returns on Durham Company have a covariance with the market of 0.0635 and
that the variance of the market returns is 0.04326. The market risk premium is 9.4 percent
and the expected return on Treasury bills is 4.9 percent. What is the required return of
Durham Company?
4. A share of stock with a beta of .75 now sells for $50. Investors expect the stock to pay a
year-end dividend of $2. The T-bill rate is now 4 percent, and the market risk-premium is 8
percent.
(a) If the stock is perceived to be fairly priced today, what must be investors expectation
of the stock price at the end of the year?
(b) Suppose investors actually believe the stock will sell for $54 at year-end. Is the stock
a good or bad buy? What will investors do? At what price will the stock reach an
equilibrium at which it is again perceived to be fairly priced?
5. The Treasury bill rate is 4 percent, and the expected return on the market portfolio is 12
percent. On the basis of the capital asset pricing model:
(a) What is the risk premium on the market?
(b) What is the required return on an investment with a beta of 1.5?
(c) If the market expects a return of 11.2 percent from stock ABC, what is its beta?
6. Percival Construction has $10 million invested in long-term corporate bonds. This bond
portfolios expected annual rate of return is 9 percent, and the annual standard deviation
is 10 percent. Amanda Reconwith, Percivals nancial advisor, recommends that Percival
consider investing in an index fund which closely tracks the Standard and Poors 500 index.
The index has an expected return of 14 percent, and its standard deviation is 16 percent.
(a) Suppose Percival puts all its money in a combination of the index fund and Treasury
bills. Can he thereby improve his expected rate of return without changing the risk of
the portfolio? The Treasury bill yield is a riskless 6 percent.
(b) Could Percival do even better by investing equal amounts in the corporate bond portfolio
and the index fund? The corelation between the bond portfolio and the index fund is
0.1.
7. (a) The expected return on a given ecient portfolio is 25% and its standard deviation is 4%.
Suppose that the risk-free rate is 5% and the expected return on the market portfolio of
risky assets is 20%. In this environment, what expected rate of return would a security
earn if it had a 0.5 correlation with the market and a standard deviation of 2%?
(b) What is the beta of an ecient portfolio with r
p
= 20% if r
f
= 5%, r
m
= 15%, and

m
= 20%? What is its standard deviation? What is its correlation with the market?