Exam 13: Return, Risk, and the Security Market Line

The market has an expected rate of return of 9.8%. Long-term government bonds are expected to yield 4.5% and Treasury bills are expected to yield 3.4%. The inflation rate is 3.1%. What is the market risk premium?

Why do we need to make the switch from historical to expected? Why not use historical returns or expected returns for all analysis?

The Inferior Goods Co. stock is expected to earn 14% in a recession, 6% in a normal economy, and lose 4% in a booming economy. The probability of a boom is 20% while the probability of a normal economy is 55% and the chance of a recession is 25%. What is the expected rate of return on this stock?

Draw the SML and plot asset C such that it has less risk than the market but plots above the SML, and asset D such that it has more risk than the market and plots below the SML. (Be sure to indicate where the market portfolio is on your graph.) Explain how assets like C or D can plot as they do and explain why such pricing cannot persist in a market that is in equilibrium.

Diversifiable risks are generally associated with an individual firm or industry.

The rate of return on the common stock of Flowers by Flo is expected to be 14% in a boom economy, 8% in a normal economy, and only 2% in a recessionary economy. The probabilities of these economic states are 20% for a boom, 70% for a normal economy, and 10% for a recession. What is the variance of the returns on the common stock of Flowers by Flo?

For a stock with beta equal to 1.5 signifies that the stock has a 50% higher expected return than the average stock.

What is the standard deviation of a portfolio which is comprised of $8,400 invested in stock S and $3,600 in stock T?

What is the portfolio expected return and the portfolio beta if you invest 30% in A, 30% in B and 40% in the risk-free asset?

The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free asset is referred to as the:

What is the portfolio weight of stock B given the following information?

What is the standard deviation of returns for asset B?

Is it possible for an asset to have a negative beta? (Hint: yes) What would the expected return on such an asset be? Why?

You form a portfolio by investing equally in A (beta = 0.8), B (beta = 1.2), the risk-free asset, and the market portfolio. What is your portfolio beta?

An investment firm is considering a portfolio with equal weighting in a cyclical stock and a countercyclical stock. It is expected that there will be three economic states; Good, Average and Bad, each with equal probabilities of occurrence. The cyclical stock is expected to have returns of 12%, 5% and 1% in Good, Average and Bad economies respectively. The countercyclical stock is expected to have returns of -8%, 2% and 14% in Good, Average and Bad economies respectively. Given this information, calculate portfolio variance.

What is the expected return on asset A if it has a beta of 0.3, the expected market return is 14%, and the risk-free rate is 5%?

Provide a definition for security market line (SML).

The standard deviation of a portfolio will tend to increase when:

Lower consumer spending than expected is considered an example of unsystematic risk.

What is the variance of the following returns?