Exam 10: Estimating Risk and Return

A manager believes his firm will earn an 18 percent return next year. His firm has a beta of 1.75, the expected return on the market is 13 percent, and the risk-free rate is 5 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is under-valued or over-valued.

This model includes an equation that relates a stock's required return to an appropriate risk premium:

You own $10,000 of Denny's Corp stock that has a beta of 3.2. You also own $15,000 of Qwest Communications (beta = 1.9) and $15,000 of Southwest Airlines (beta = 0.4). Assume that the market return will be 13 percent and the risk-free rate is 5.5 percent. What is the risk premium of the portfolio?

Required Return If the risk-free rate is 8 percent and the market risk premium is 2 percent, what is the required return for the market?

Stock A has a required return of 19%. Stock B has a required return of 11%. Assume a risk-free rate of 4.75%. By how much does Stock A's risk premium exceed the risk premium of Stock B?

List and describe the three basic levels of market efficiency,

Portfolio Beta You own $2,000 of City Steel stock that has a beta of 2.5. You also own $8,000 of Rent-N-Co (beta = 1.9) and $4,000 of Lincoln Corporation (beta = 0.25). What is the beta of your portfolio?

Which of these is the line on a graph of return and risk (standard deviation) from the risk-free rate through the market portfolio?

Risk Premium The annual return on the S&P 500 Index was 18.1 percent. The annual T-bill yield during the same period was 6.2 percent. What was the market risk premium during that year?

IBM's stock price is $22, it is expected to pay a $2 dividend, and analysts expect the firm to grow at 10% per year for the next 5 years. TDI's stock price is $10, it is expected to pay a $1 dividend, and analysts expect the firm to grow at 12% per year for the next 5 years. What is the difference in the two firms' required rate of returns?

Under/Over-Valued Stock A manager believes his firm will earn a 7.5 percent return next year. His firm has a beta of 2, the expected return on the market is 5 percent, and the risk-free rate is 2 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is under-valued or over-valued.

CAPM Required Return A company has a beta of 3.25. If the market return is expected to be 14 percent and the risk-free rate is 5.5 percent, what is the company's required return?

In 2000, the S&P500 Index earned 11% while the T-bill yield was 4.4%. Given this information, which of the following statements is correct with respect to the market risk premium?

Which of the following statements is incorrect?

Stock A has a required return of 12%. Stock B has a required return of 15%. Assume a risk-free rate of 4.75%. Which of the following is a correct statement about the two stocks?

Investor enthusiasm causes an inflated bull market that drives prices too high, ending in a dramatic collapse in prices.

This has not been released to the public, but is known by few individuals, likely company insiders.

The average annual return on the S&P 500 Index from 1986 to 1995 was 17.6 percent. The average annual T-bill yield during the same period was 9.8 percent. What was the market risk premium during these ten years?

Expected Return Risk Compute the standard deviation of the expected return given these three economic states, their likelihoods, and the potential returns:

Which of the following is incorrect?