Financial Managerial

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Tutorial 1: Risk and Return

1.Expected return. A stock’s returns have the following distribution:

Demand for the company’s product| Probability of this demand occurring| Rate of return if this demand occurs| Weak| 0.1| (50%)|
Below average| 0.2| (5%)|
Average| 0.4| 16|
Above average| 0.2| 25|
strong| 0.1| 60|
| 1.0| |

Calculate the stock’s expected return, standard deviation, and the coefficient of variation.

2.Required rate of return. Stock R has a beta of 1.5, Stock S has a beta of 0.75, the expected rate of return on an average stock is 13%, and the risk free rate is 7%. By how much does the required return on the riskier stock exceed the required return on the less risky stock?

3.Required rate of return. Suppose rRF =9%, rM = 14% and bi = 1.3

a. What is ri, the required return on stock i?

b.Now suppose rRF (1) increases to 10% or (2) decreases to 8%. The slope of the SML remains constant. How would this affect rM and ri?

c.Now assume rRF remains at 9%, but rM (1) increases to 16% or (2) falls to 13%. The slope of the SML does not remain constant. How would this affect ri?

4.Evaluating risk and return.
Stock X has an expected return of 10%, a beta coefficient of 0.9, and a 35% standard deviation of expected return.
Stock Y has a 12.5% expected return, a beta coefficient of 1.2, and a 25% standard deviation.
The risk free rate is 6%, and the market risk premium is 5%.

a.Calculate each stock’s coefficient of variation.

b. Which stock is riskier for a diversified investor?

c.Calculate each stock’s required rate of return.

d.On the basis of the two stocks’ expected and required returns, which stock will be more attractive to a diversified investor?...
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