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8-1
CV =
8-2
= 2.34.
Investment
$35,000
40,000
Total $75,000
Beta
0.8
1.4
8-4
8-5
=
=
=
=
r Piri
i1
8-6
a.
.
rY
(r r)
i
Pi
i1
b. =
2X
= (-10% 12%)2(0.1) + (2% 12%)2(0.2) + (12% 12%)2(0.4)
+ (20% 12%)2(0.2) + (38% 12%)2(0.1) = 148.8.
X = 12.20% versus 20.35% for Y.
CVX = X/
r
X
$400,000
$600,000
$1,000,000
$2,000,000
$4,000,000
$4,000,000
$4,000,000
$4,000,000
=
(1.50) +
(-0.50) +
(1.25) +
8-7
Portfolio beta
(0.75)
bp = (0.1)(1.5) + (0.15)(-0.50) + (0.25)(1.25) + (0.5)(0.75)
= 0.15 0.075 + 0.3125 + 0.375 = 0.7625.
rp = rRF + (rM rRF)(bp) = 6% + (14% 6%)(0.7625) = 12.1%.
Alternative solution: First, calculate the return for each stock using the CAPM equation
[rRF + (rM rRF)b], and then calculate the weighted average of these returns.
rRF = 6% and (rM rRF) = 8%.
Stock
A
B
C
Investment
$ 400,000
600,000
1,000,000
Beta
1.50
(0.50)
1.25
Weight
0.10
0.15
0.25
D
Total
2,000,000
$4,000,000
0.75
12
0.50
1.00
In equilibrium:
rJ
rJ =
= 12.5%.
8-10
An index fund will have a beta of 1.0. If rM is 12.0% (given in the problem) and the riskfree rate is 5%, you can calculate the market risk premium (RPM) calculated as rM rRF
as follows:
r = rRF + (RPM)b
12.0%= 5% + (RPM)1.0
7.0% = RPM.
Now, you can use the RPM, the rRF, and the two stocks betas to calculate their required
returns.
Bradford:
rB =
=
=
=
rRF + (RPM)b
5% + (7.0%)1.45
5% + 10.15%
15.15%.
Farley:
rF =
=
=
=
rRF + (RPM)b
5% + (7.0%)0.85
5% + 5.95%
10.95%.
rs = 6% + (6.5%)1.7 = 17.05%.
8-12
8-13
8-14
$142,500
$7,500
$150,000
$150,000
Old portfolio beta
=
(b) +
(1.00)
1.12 = 0.95b + 0.05
1.07 = 0.95b
1.1263 = b.
New portfolio beta = 0.95(1.1263) + 0.05(1.75) = 1.1575 1.16.
Alternative solutions:
1. Old portfolio beta = 1.12 = (0.05)b1 + (0.05)b2 + ... + (0.05)b20
( bi )
1.12 =
bi
(0.05)
= 1.12/0.05 = 22.4.
New portfolio beta = (22.4 1.0 + 1.75)(0.05) = 1.1575 1.16.
2.
excluding the stock with the beta equal to 1.0 is 22.4 1.0 = 21.4, so the
beta of the portfolio excluding this stock is b = 21.4/19 = 1.1263. The beta of the
new portfolio is:
1.1263(0.95) + 1.75(0.05) = 1.1575 1.16.
8-15
8-16
Step 1:
8-17
After additional investments are made, for the entire fund to have an expected return
of 13%, the portfolio must have a beta of 1.5455 as shown below:
13% = 4.5% + (5.5%)b
b = 1.5455.
Since the funds beta is a weighted average of the betas of all the individual
investments, we can calculate the required beta on the additional investment as
follows:
($20,000,000)(1.5)
$25,000,000
1.5455
=
1.5455
= 1.2 + 0.2X
0.3455
= 0.2X
X= 1.7275.
8-18
$5,000,000X
$25,000,000
+
8-19
rY
rY = 6% + 5%(1.2)
= 12%.
rX
d. rX = 10.5%;
rY
rY = 12%;
= 10%.
= 12.5%.
Stock Y would be most attractive to a diversified investor since its expected return
of 12.5% is greater than its required return of 12%.
e. bp = ($7,500/$10,000)0.9 + ($2,500/$10,000)1.2
= 0.6750 + 0.30
= 0.9750.
rp = 6% + 5%(0.975)
= 10.875%.
f.
If RPM increases from 5% to 6%, the stock with the highest beta will have the
largest increase in its required return. Therefore, Stock Y will have the greatest
increase.
Check:
8-20
rX = 6% + 6%(0.9)
= 11.4%.
rY = 6% + 6%(1.2)
= 13.2%.
rA
(18.00%)
33.00
15.00
(0.50)
27.00
11.30
20.79
1.84
rB
(14.50%)
21.80
30.50
(7.60)
26.30
11.30
20.78
1.84
Portfolio
(16.25%)
27.40
22.75
(4.05)
26.65
11.30
20.13
1.78
e. A risk-averse investor would choose the portfolio over either Stock A or Stock B
alone, since the portfolio offers the same expected return but with less risk. This
result occurs because returns on A and B are not perfectly positively correlated (rAB
= 0.88).
rM
8-21
a.