Question 1

PPO stock has a beta of 0.97 and an expected return of 11.22 percent.The risk-free rate of return is 2.48 percent.What is the expected return on the market?

Accepted Answer

0.1122 = 0.0248 + 0.97(R_m − 0.0248) R_m= 0.1149,or 11.49%

Question 2

The stock of Martin Industries has a beta of 1.17.The risk-free rate of return is 2.9 percent,and the market risk premium is 6.93 percent.What is the expected rate of return on Martin Industries stock?

Accepted Answer

E(r)= 0.029 + 1.17(0.0693)= 0.1101,or 11.01%

Question 3

OLG stock has a beta of 0.98 and an expected return of 10.52 percent.The risk-free rate of return is 3.02 percent,and the market rate of return is 10.47 percent.Which one of the following statements is true given this information?

Accepted Answer

E(r)= 0.0302 + 0.98(0.1047 − 0.0302)= 0.1009,or 10.09% OLG stock is underpriced as its actual expected return exceeds the CAPM return.An underpriced stock graphs above the security market line as its return is greater than it should be based on the stock's level of risk.

Question 4

The market has an expected rate of return of 10.29 percent.The long-term government bond is expected to yield 4.73 percent,and the U.S.Treasury bill is expected to yield 3.21 percent.The inflation rate is 3.09 percent.What is the market risk premium?

Accepted Answer

Market risk premium = 10.29% − 3.21% = 7.08%

Question 5

Assume the risk-free rate of return is 6.5 percent and the market rate of return is 11.2 percent.Stock A with a beta of 0.88 and an expected return of 9.79 percent; Stock B with a beta of 1.26 and an expected return of 11.36 percent; Stock C with a beta of 1.47 and an expected return of 12.28 percent; Stock D with a beta of 0.79 and an expected return of 10.61 percent.Which one of the following stocks,if any,is correctly priced according to CAPM?

Accepted Answer

E(r)_A = 0.065 + 0.88(0.112 − 0.065)= 0.1064,or 10.64 percent E(r)_B = 0.065 + 1.26(0.112 − 0.065)= 0.1242,or 12.42 percent E(r)_C = 0.065 + 1.47(0.112 − 0.065)= 0.1341,or 13.41 percent E(r)_D = 0.065 + 0.79(0.112 − 0.065)= 0.1021,or 10.21 percent None of the stocks are correctly priced.

Question 6

The expected return on HiLo stock is 13.36 percent while the expected return on the market is 11.87 percent.The beta of HiLo is 1.14.What is the risk-free rate of return?

Accepted Answer

0.1336= R_f + 1.14(0.1187 − R_f) R_f = 0.0123 or 1.23%

Question 7

The risk-free rate of return is 2.2 percent,and the market risk premium is 7.46 percent.What is the expected rate of return on a stock with a beta of 1.08?

Accepted Answer

E(r)= 0.022 + 1.08(0.0746)= 0.1026,or 10.26%

Question 8

Alpha stock has a beta of 1.29.The risk-free rate of return is 3.2 percent,and the market rate of return is 10.7 percent.What is the Alpha stock risk premium?

Accepted Answer

Risk premium = 1.29(0.107 − 0.032)= 0.0968,or 9.68%

Question 9

Stock A has a beta of 0.87 and an expected return of 9.21 percent.Stock B has a beta of 1.36 and an expected return of 10.58 percent.Stock C has a beta of 1.12 and an expected return of 10.68 percent.The risk-free rate is 2.7 percent,and the market risk premium is 6.8 percent.Which of these stocks are underpriced?

Accepted Answer

E(r)_A = 0.027 + 0.87(0.068)= 0.0862,or 8.62% E(r)_B = 0.027 + 1.36(0.068)= 0.1195,or 11.95% E(r)_C = 0.027 + 1.12(0.068)= 0.1032,or 10.32% Stocks A and C are underpriced because their expected rate of return exceeds the CAPM rate.

Quiz 11: Return and Risk: The Capital Asset Pricing Model Capm