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## We are providing solutions of Question 01 – 10 here, Solutions to Self-Correction

Problems are given at the end of chapter 05, moreover we have these solutions too
but complete solutions regarding to Problems Questions are being provided @ BBA
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All of the data provided here is only for educational purpose & not for business.

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Nouman Awan

noumanawan@gawab.com

http://www.bbafellows.forum-motion.net
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Problems Solutions : Question 01 – 10

1 )

b) There is a 30 percent probability that the actual return will be zero (prob.
E(R) = 0 is 20%) or less (prob. E(R) < is 10%). Also, by inspection we see that the
distribution is skewed to the left.

## 1.30 and 1.35. These standard deviations correspond to areas

under the curve of .0968 and .0885 respectively. This means that
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there is approximately a 9% probability that actual return will be

9.13%.)

## 30 percent: Standardized deviation = (30% - 20%)/15%

=+0.667. Probability of 30 percent or
more return = (approx.) 25 percent.

## 40 percent: Standardized deviation = (40% - 20%)/15%

=+1.333.Probability of 40 percent or more return =
(approx.) 9 percent -- (i.e., the same percent as in part (a)).

## 50 percent: Standardized deviation = (50% - 20%)/15%

=+2.00.Probability of 50 percent or more return =2.28
percent.
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3) As the graph will be drawn by hand with the characteristic line fitted

by eye, they will not all be the same. However, students should reach the same

general conclusions.

## ( Copyrights : Pearson Education 2005 .)

The beta is approximately 0.5. This indicates that excess returns for the

stock fluctuate less than excess returns for the market portfolio. The stock

has much less systematic risk than the market as a whole. It would be a

defensive investment.
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4) Req. (RA) = .07 + (.13 - .07) (1.5) = .16

## 5 ) Expected return = .07 + (.12 - .07)(1.67) = .1538, or 15.38%

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6)
Perhaps the best way to visualize the problem is to plot expected returns

against beta. This is done below. A security market line is then drawn from the

risk-free rate through the expected return for the market portfolio which has a

beta of 1.0

## ( Copyrghts : Pearson Education 2005 )

The (a) panel, for a 10% risk-free rate and a 15% market return, indicates

## that stocks 1 and 2 are undervalued while stock 4 is overvalued.Stock 3 is

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priced so that its expected return exactly equals the return required by

## the market; it is neither overpriced nor underpriced.

The (b) panel, for a 12% risk-free rate and a 16% market return, shows all

## of the stocks overvalued. It is important to stress that the relationships

are expected ones. Also, with a change in the risk-free rate, the betas

7)
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get

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9)

## = .08 + .0669 = .1469 or 14.69%

10 )
a) Required return = .10 + (.14 - .06)(1.50)

## V = D1/(ke - g) = \$3.40/(.26 - .06) = \$3.40/.20 = \$17.00

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b) Since the common stock is currently selling for \$30 per share in

## company’s common stock appears to be “overpriced.” Paying

\$30 per share for the stock would likely result in our