Professional Documents
Culture Documents
Part I: Questions
2. Explain how differences in allocations between the risk-free security and the market
portfolio can determine the level of market risk.
An investor must decide how much of their portfolio to invest in risk free securities (beta
= 0) when determining how much risk to take and now much to invest into the market
(beta = 1) to accomplish their desired level of risk. An example would be that a more
inclined investor towards risk may invest 80% into the risk free market, and 20% into the
stock market. This allocation would have a beta = .20. While a less risk inclined person
might have allocations on the opposite scale of 20% risk free and 80% invested into the
stock market, which would be beta = .80. If an investors varies their amount of
allocations it allows for the risk free market and market portfolio to vary the amount of
their overall assumed risk (Weston, 2001).
1. Based on the probability and percentage of return for the three economic states in the
table below, compute the expected return.
Economic State Probability Percentage of Return
Fast Growth 0.10 60
2. If the risk-free rate is 7 percent and the risk premium is 4 percent, what is the required
return?
3. Suppose that the average annual return on the Standard and Poor's 500 Index from 1969
to 2005 was 14.8 percent. The average annual T-bill yield during the same period was 5.6
percent. What was the market risk premium during these 10 years?
4. Conglomco has a beta of 0.32. If the market return is expected to be 12 percent and the
risk-free rate is 5 percent, what is Conglomco's required return? Use the capital asset
pricing model (CAPM) to calculate Conglomco's required return.
Beta = 0.32
Market Return = 12%
Risk Free Return = 5%
Required Return= 5% + 0.32*(12%-5%) = 7.24%
5. Calculate the beta of a portfolio that includes the following stocks:
Conglomco stock, which has a beta of 3.9 and comprises 35 percent of the
portfolio.
Supercorp stock, which has a beta of 1.7 and comprises 25 percent of the
portfolio.
Megaorg stock, which has a beta of 0.3 and comprises 40 percent of the portfolio.