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1.Here are data on two companies. The T-bill rate is 4% and the market risk premium is 6%.


Company $1 Discount Store Everything $5
Forecast return 12% 11%
Standard deviation of returns 8% 10%
Beta 1.5 1.0
What would be the fair return for each company, according to the capital asset pricing model (CAPM)?

Company Expected Return
$1 Discount Store %
Everything $5 %
2.Here are data on two companies. The T-bill rate is 4% and the market risk premium is 6%.
Company $1 Discount Store Everything $5
Forecast return 12% 11%
Standard deviation of returns 8% 10%
Beta 1.5 1.0

Characterize each company in the above table as underpriced, overpriced, or properly priced.

3. Kaskin, Inc., stock has a beta of 1.2 and Quinn, Inc., stock has a beta of .6. Which of the following statements is most accurate?
a. The expected rate of return will be higher for the stock of Kaskin, Inc., than that of Quinn, Inc.
b. The stock of Kaskin, Inc., has more total risk than Quinn, Inc.
c. The stock of Quinn, Inc., has more systematic risk than that of Kaskin, Inc.
4.A share of stock is now selling for $100. It will pay a dividend of $9 per share at the end of the year. Its beta is 1. What do investors expect the stock to sell for at the end of the year? Assume the risk-free rate is 8% and the expected rate of return on the market is 18%.
5.Consider the single factor APT. Portfolio A has a beta of 1.3 and an expected return of 21%. Portfolio B has a beta of .7 and an expected return of 17%. The risk-free rate of return is 8%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _________.
a. A; A
b. A; B
c. B; A
d. B; B

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Answer:

Explanation:

1.

According to the CAPM model

Fair return = Risk-free rate of return + (Beta × Market Premium)

For $1 discount store:

Expected return = 4% +(1.5 × 6%)

Expected return = 0.04 + (1.5 × 0.06)

Expected return = 0.04 + 0.09

Expected return = 0.13

Expected return = 13%

For everything $5

Expected Return = 4% + (1 × 6%)

Expected return =  0.04 + (1 × 0.06)

Expected return = 0.04 + 0.06

Expected return = 0.10

Expected return = 10%

2.

From the above calculation;

For $1 discount store:

Since the expected return is greater than the forecasted return at 12%.

Thus, it is overpriced.

For everything $5

Here, it is obvious from the above calculation that the expected return is lesser than the forecasted return at 11%.

Therefore, it is underpriced.

3) Beta can be defined as the security change that takes place due to market functuations. Thus, Beta manages the systematic risk associated with firms. From the information given, Kaskin Inc. has a more systematic risk(beta) than Quinn Inc. Thus, option A is the most accurate.

4)

To first find the growth rate by using CAPM model.

Required return = Risk free return + [tex]\beta[/tex] (market return - risk free return)

Required return = 0.08 + 1(0.18 - 0.08)

Required return = 18%

Using the formula:

Required return = (next year dividend/current price) + growth rate

18% = (9/100) + g

0.18 = 0.09 g

g = 0.09

Growth rate g = 9%

To determine the price at year 1; we have:

= [tex]year \ 1 \ dividend \times \dfrac{1+g}{ke-g}[/tex]

[tex]= 9 \times \dfrac{1+0.09}{0.18 - 0.09}[/tex]

= $109.00

Therefore, the investor can earn a profit of $9 after selling the stock for $109 at the end of the year 1.

5.

According to beta

For portfolio A.

Risk premium per unit = (21 - 8)%/1.3

Risk premium per unit = (0.21 - 0.08)/1.3

Risk premium per unit = 0.1

Risk premium per unit = 10%

For portfolio B.

Risk premium per unit = (17 - 8)%/0.7

Risk premium per unit = (0.17 - 0.08)/0.7

Risk premium per unit = 0.1286

Risk premium per unit = 12.86%

From above, it is clear that the risk associated with portfolio B is lesser compared to portfolio A.

Thus; the correct option is b. A; B