Chapter 11

Problems 1-38

Input boxes in tan

Output boxes in yellow
Given data in blue
Calculations in red
Answers in green

NOTE: Some functions used in these spreadsheets may require that

the "Analysis ToolPak" or "Solver Add-in" be installed in Excel.
To install these, click on "Tools|Add-Ins" and select "Analysis ToolPak"
and "Solver Add-In."
sis ToolPak"
Chapter 11
Question 1

Input area:

Shares of A 165
Share price of A $ 43.00
Shares of B 120
Share price of B $ 74.00

Output area:

Portfolio value $ 15,975

Weight of A 0.4441

Weight of B 0.5559
Chapter 11
Question 2

Input area:

Stock A $ value $ 2,700

Stock A E(R) 9.50%
Stock B $ value $ 3,800
Stock B E(R) 14.00%

Output area:

Weight of A 0.4154

Weight of B 0.5846

Portfolio E(R) 12.13%

Chapter 11
Question 3

Input area:

Weight of X 20.00%
Weight of Y 45.00%
Weight of Z 35.00%
Stock X E(R) 11.00%
Stock Y E(R) 17.00%
Stock Z E(R) 14.00%

Output area:

Portfolio E(R) 14.75%

Chapter 11
Question 4

Input area:

Portfolio value $ 10,000

Stock X E(R) 13.00%
Stock Y E(R) 8.50%
Portfolio E(R) 11.90%

Output area:

Weight of Stock X 0.7556

Weight of Stock Y 0.2444

Dollar in Stock X $ 7,555.56

Dollars in Stock Y $ 2,444.44

Chapter 11
Question 5

Input area:

State Probability Stock A Stock B

Recession 0.30 0.06 (0.20)
Normal 0.55 0.07 0.13
Boom 0.15 0.11 0.33

Output area:

Stock A Probability Return Product

Recession 0.30 0.06 0.0180
Normal 0.55 0.07 0.0385
Boom 0.15 0.11 0.0165
E(R) = 0.0730

Standard Deviation 1.62%

Stock B Probability Return Product

Recession 0.30 (0.20) (0.0600)
Normal 0.55 0.13 0.0715
Boom 0.15 0.33 0.0495
E(R) = 0.0610

Standard Deviation 18.41%

 Return Squared
Deviation Deviation Product
(0.0130) 0.00017 5.07E-05
(0.0030) 0.00001 4.95E-06
0.0370 0.00137 0.00020535
Variance = 0.00026

Return Squared
Deviation Deviation Product
(0.2610) 0.06812 0.0204363
0.0690 0.00476 0.00261855
0.2690 0.07236 0.01085415
Variance = 0.03391
Chapter 11
Question 6

Input area:

State Probability Stock A

Depression 0.15 -0.105
Recession 0.30 0.059
Normal 0.45 0.130
Boom 0.10 0.211

Output area:

Stock A Probability Return Product

Depression 0.15 -0.105 (0.0158)
Recession 0.30 0.059 0.0177
Normal 0.45 0.130 0.0585
Boom 0.10 0.211 0.0211
E(R) = 0.0816

Standard Deviation 9.00%

 Return Squared
Deviation Deviation Product
(0.1866) 0.03480 0.0052201354
(0.0226) 0.00051 0.0001525508
0.0485 0.00235 0.0010563311
0.1295 0.01676 0.0016757303
Variance = 0.00810
Chapter 11
Question 7

Input area:

Weight of G 20.00%
Weight of J 55.00%
Weight of K 25.00%
Stock G E(R) 9.00%
Stock J E(R) 11.00%
Stock K E(R) 14.00%

Output area:

Portfolio E(R) 11.35%

 Chapter 11
Question 8

Input area:

State Probability Stock A Stock B Stock C

Boom 0.65 0.06 0.16 0.33
Bust 0.35 0.14 0.02 (0.06)

a. weights 0.33 0.33 0.33

b. weights 0.20 0.20 0.60

Output area:

Portfolio
a. Stock A Probability Return Product
Recession 0.65 0.1833 0.1192
Boom 0.35 0.0333 0.0117
E(R) = 0.1308

Return Squared
b. Stock A Probability Return Product Deviation Deviation Product
Recession 0.65 0.2420 0.1573 0.0861 0.00741 0.0048185865
Boom 0.35 (0.0040) (0.0014) (0.1599) 0.02557 0.0089488035
E(R) = 0.1559 Variance = 0.013767
Chapter 11
Question 9

Input area:

State Probability Stock A Stock B Stock C

Boom 0.25 0.24 0.45 0.33
Good 0.40 0.09 0.10 0.15
Poor 0.30 0.03 (0.10) (0.05)
Bust 0.05 (0.05) (0.25) (0.09)

weights 0.30 0.40 0.30

Output area:

Portfolio Return Squared

Stock A Probability Return Product Deviation Deviation Product
Boom 0.25 0.3510 0.0878 0.2394 0.05729 0.014322106
Good 0.40 0.1120 0.0448 0.0004 0.00000 4.9E-08
Poor 0.30 (0.0460) (0.0138) (0.1577) 0.02485 0.007456057
Bust 0.05 (0.1420) (0.0071) (0.2537) 0.06434 0.003216916
E(R) = 0.1117 Variance = 0.02500

Standard Deviation 15.81%

Chapter 11
Question 10

Input area:

Weight of Q 15.00%
Weight of R 35.00%
Weight of S 30.00%
Weight of T 20.00%
Beta of Q 0.75
Beta of R 1.90
Beta of S 1.38
Beta of T 1.16

Output area:

Portfolio E(R) 1.42

Chapter 11
Question 11

Input area:

Weight of risk-free 33.33%

Weight of Stock A 33.33%
Weight of Stock B 33.33%
Beta of risk-free 0.00
Beta of Stock A 1.73
Beta of Portfolio 1.00

Output area:

Beta of Stock B 1.27

Chapter 11
Question 12

Input area:

Beta 1.15
Market E(R) 10.60%
Risk-free return 4.50%

Output area:

Stock E(R) 11.52%

Chapter 11
Question 13

Input area:

Stock E(R) 13.40%

Market risk premium 7.00%
Risk-free return 3.80%

Output area:

Stock beta 1.37

Chapter 11
Question 14

Input area:

Stock E(R) 13.40%

Stock beta 1.20
Risk-free return 4.40%

Output area:

Market E(R) 11.90%

Chapter 11
Question 15

Input area:

Stock E(R) 11.20%

Stock beta 1.15
Market E(R) 10.40%

Output area:

Risk-free 5.07%
 Chapter 11
Question 16

Input area:

Stock beta 1.13

Stock E(R) 12.10%
Risk-free return 3.60%

a. Weight of stock 50.00%

b. Portfolio beta 0.50
c. Portfolio E(R) 10.00%
d. Portfolio beta 2.26

Output area:

a. Portfolio E(R) 7.85%

b. Weight of stock 0.4425

Weight of risk-free 0.5575

c. Weight of stock 0.7529

Portfolio beta 0.851

d. Weight of stock 200.00%

Weight of risk-free -100.00%

The portfolio is invested 200 percent

in the stock and -100 percent in the
risk-free asset. This represents
borrowing at the risk-free rate to buy
more of the stock.
Chapter 11
Question 17

Input area:

Stock E(R) 11.90%

Stock beta 1.20
Risk-free return 4.00%

Output area:

Slope of SML 0.0658

Weight of W Portfolio E(R) Portfolio beta

0.00% 4.00% 0.000
25.00% 5.98% 0.300
50.00% 7.95% 0.600
75.00% 9.93% 0.900
100.00% 11.90% 1.200
125.00% 13.88% 1.500
150.00% 15.85% 1.800
Chapter 11
Question 18

Input area:

Stock Y beta 1.20

Stock Y E(R) 12.70%
Stock Z beta 0.90
Stock Z E(R) 11.10%
Risk-free rate 4.50%
Market risk premium 7.10%

Output area:

SML reward-to-risk 0.0710

Reward-to-risk ratios

Stock Y 0.0683

Stock Z 0.0733

Return predicted by CAPM

Stock Y 13.02%

Stock Z 10.89%

Stock Y is overvalued
Stock Z is undervalued
Chapter 11
Question 19

Input area:

Stock Y beta 1.20

Stock Y E(R) 12.70%
Stock Z beta 0.90
Stock Z E(R) 11.10%
Market risk premium 7.10%

Output area:

Risk-free rate 6.30%

Chapter 11
Question 20

Input area:

Large-company stocks 12.10%

Long-term government bonds 6.10%
Small company stock 16.70%
Treasury bills 3.50%

Output area:

Large-company stocks and

long-term government bond
portfolio 9.10%

Small company stocks and

Treasury bill portfolio 10.10%
Chapter 11
Question 21

Output area:

(E[RA] - RF)/βA = (E[RB] - RF)/βB

RPA/βA = RPB/βB
βB/βA = RPB/RPA
 Chapter 11
Question 22

Input area:

State Probability Stock A Stock B Stock C

Boom 0.25 0.20 0.25 0.60
Normal 0.55 0.15 0.11 0.05
Bust 0.20 0.01 (0.15) (0.50)

weights 0.40 0.40 0.20

b. T-bill rate 3.80%

c. Inflation rate 3.50%

Output area:

Portfolio Return Squared

State Probability Return Product Deviation Deviation Product
Boom 0.25 0.300 0.0750 0.1935 0.03744 0.0093605625
Poor 0.55 0.114 0.0627 0.0075 0.00006 3.09375E-05
Bust 0.20 (0.156) (0.0312) (0.2625) 0.06891 0.01378125
E(R) = 0.1065 Variance = 0.02317

Standard Deviation 15.22%

b. Expected risk premium 6.85%

c. Approximate expected real return 7.15%

Exact expected real return 6.91%

Approximate real risk-free rate 0.30%

Exact real risk-free rate 0.29%

Approximate expected real risk premium 6.85%

Exact expected real risk premium 6.62%
Chapter 11
Question 23

Input area:

Total investment $ 1,000,000

Portfolio beta 1.00

Asset Investment Beta

Stock A $ 180,000 0.75
Stock B $ 290,000 1.25
Stock C 1.45
Risk-free asset

Output area:

Asset Investment Beta

Stock A $ 180,000.00 0.75
Stock B $ 290,000.00 1.25
Stock C $ 346,551.72 1.45
Risk-free asset $ 183,448.28 0.00
Chapter 11
Question 24

Input area:

Total investment $100,000

Portfolio E(R) 12.90%
Stock X E(R) 11.20%
Stock X beta 1.30
Stock Y E(R) 7.70%
Stock Y beta 0.80

Output area:

Weight of Stock X 1.48571

Weight of Stock Y -0.48571

Dollar amount in X $ 148,571.43

Dollar amount in Y $ (48,571.43)

Portfolio beta 1.54

This represents shorting Stock Y.

Chapter 11
Question 25

Input area:

State Probability Stock A Stock B

Bear 0.33 0.108 (0.067)
Normal 0.33 0.126 0.113
Bull 0.33 0.064 0.276

Output area:

Return Squared
Stock A Probability Return Product Deviation Deviation Product
Recession 0.33 0.11 0.0360 0.0087 0.00008 2.503704E-05
Normal 0.33 0.13 0.0420 0.0267 0.00071 0.000237037
Boom 0.33 0.06 0.0213 (0.0353) 0.00125 0.000416148
E(R) = 0.0993 Variance = 0.00068

Standard Deviation = 2.60%

Return Squared
Stock B Probability Return Product Deviation Deviation Product
Recession 0.33 (0.07) (0.0223) (0.1743) 0.03039 0.010130704
Normal 0.33 0.11 0.0377 0.0057 0.00003 1.07037E-05
Boom 0.33 0.28 0.0920 0.1687 0.02845 0.009482815
E(R) = 0.1073 Variance = 0.01962

Standard Deviation = 14.01%

Return Deviation Return Deviation Product times

Stock A Stock B Probability
Recession 0.0087 (0.1743) (0.000504)
Normal 0.0267 0.0057 0.000050
Boom (0.0353) 0.1687 (0.001987)
Covariance = (0.002440)

Correlation = (0.6688)
Chapter 11
Question 26

Input area:

State Probability Stock A Stock B

Bear 0.30 (0.020) 0.034
Normal 0.55 0.138 0.062
Bull 0.15 0.218 0.092

Output area:

Return Squared
Stock A Probability Return Product Deviation Deviation Product
Recession 0.30 (0.02) (0.0060) (0.1226) 0.01503 0.004509228
Normal 0.55 0.14 0.0759 0.0354 0.00125 0.000689238
Boom 0.15 0.22 0.0327 0.1154 0.01332 0.001997574
E(R) = 0.1026 Variance = 0.00720

Standard Deviation = 8.48%

Return Squared
Stock B Probability Return Product Deviation Deviation Product
Recession 0.30 0.03 0.0102 (0.0241) 0.00058 0.000174243
Normal 0.55 0.06 0.0341 0.0039 0.00002 8.3655E-06
Boom 0.15 0.09 0.0138 0.0339 0.00115 0.000172382
E(R) = 0.0581 Variance = 0.00035

Standard Deviation = 1.88%

Return Deviation Return Deviation Product times

Stock A Stock B Probability
Recession (0.1226) (0.0241) 0.000886
Normal 0.0354 0.0039 0.000076
Boom 0.1154 0.0339 0.000587
Covariance = 0.001549

Correlation = 0.9693
 Chapter 11
Question 27

Input area:

Security F E(R) 10%

Security F standard deviation 49%
Security G E(R) 14%
Security G standard deviation 73%
Weight of F 30%
Weight of G 70%
Correlation 0.25

Output area:

a. Portfolio E(R) 12.80%

b. Portfolio variance 0.32029

Portfolio standard deviation 56.59%

 Chapter 11
Question 28

Input area:

Stock A E(R) 11%

Stock A standard deviation 39%
Stock B E(R) 13%
Stock B standard deviation 76%
Weight of A 35%
Weight of B 65%
a. Correlation 0.50
b. Correlation (0.50)

Output area:

a. Portfolio E(R) 12.30%

Portfolio variance 0.33010

Portfolio standard deviation 57.45%

b. Portfolio E(R) 12.30%

Portfolio variance 0.19524

Portfolio standard deviation 44.19%

 Chapter 11
Question 29

Input area:

E(R) Standard Deviation Correlation Beta

Stock A 0.10 0.31 (i) 0.85
Stock B 0.14 (ii) 0.50 1.40
Stock C 0.16 0.65 0.35 (iii)
Market portfolio 0.12 0.20 (iv) (v)
Risk-free asset 0.05 (vi) (vii) (viii)

Output area:

a. (i) 0.55

(ii) 0.56

(iii) 1.14

(iv) The correlation of anything with itself is one.

(v) The market has a beta of one.

(vi) By defintion, the risk-free asset has a standard deviation of zero.

(vii) The risk-free asset has a zero correlation with the market.

(vii) The risk-free asset has a beta of zero.

b. CAPM return
E(RA) 10.95% The stock is overpriced and you should sell it.

E(RB) 14.80% The stock is overpriced and you should sell it.

E(RC) 12.96% The stock is underpriced and you should buy it.
 Chapter 11
Question 30

Input area:

Market E(R) 11%

Market standard deviation 19%
Risk-free rate 4.3%
a. Portfolio standard deviation 9%
b. Portfolio expected return 20%

Output area:

Slope of CML 0.35263

a. Portfolio E(R) 7.47%

b. Portfolio standard deviation 44.52%

Chapter 11
Question 31

Input area:

Portoflio E(R) 8%
Portfolio standard deviation 17%
Risk-free rate 4.30%
Market E(R) 11%
Security correlation with market 0.45
Security standard deviation 60%

Output area:

Slope of CML 0.22

Standard deviation of market 30.78%

Beta of security 0.88

Security E(R) 10.18%

Chapter 11
Question 32

Input area:

Risk-free rate 4.70%

Market E(R) 11.20%
Market variance 0.0382
Portfolio correlation with market 0.2800
Portfolio variance 0.3285

Output area:

Market standard deviation 19.54%

Portfolio standard deviation 57.31%

Portfolio beta 0.82

Portfolio E(R) 10.04%

Chapter 11
Question 33

Input area:

State Probability Stock I Stock II

Recession 0.15 0.11 (0.25)
Normal 0.55 0.18 0.11
Boom 0.30 0.08 0.31

Market risk premium 7.50%

Risk-free rate 4.00%

Output area:

Return Squared
Stock I Probability Return Product Deviation Deviation Product
Recession 0.15 0.11 0.0165 (0.0295) 0.00087 0.0001305375
Normal 0.55 0.18 0.0990 0.0405 0.00164 0.0009021375
Boom 0.30 0.08 0.0240 (0.0595) 0.00354 0.001062075
E(R) = 0.1395 Variance = 0.00209

Standard Deviation = 4.58%

Stock I beta = 1.33

Return Squared
Stock II Probability Return Product Deviation Deviation Product
Recession 0.15 (0.25) (0.0375) (0.3660) 0.13396 0.0200934
Normal 0.55 0.11 0.0605 (0.0060) 0.00004 1.98E-05
Boom 0.30 0.31 0.0930 0.1940 0.03764 0.0112908
E(R) = 0.1160 Variance = 0.03140

Standard Deviation = 17.72%

Stock II beta = 1.01

Although Stock II has more total risk than Stock I, it has much less systematic risk, since its beta is smaller than I's.
Thus I has more systematic risk, and II has more unsystematic and total risk. Since unsystematic risk can be
diversified away, I is actually the "riskier" stock despite the lack of volatility in its returns. Stock I will have a higher
risk premium and a greater expected return.
Chapter 11
Question 34

Input area:

Security Beta Expected return

Pete Corp. 1.35 12.28%
Repete Co. 0.80 8.54%

Output area:

Risk-free rate 3.10%

Market return
With Pete 9.90%
With Repete 9.90%
 Chapter 11
Question 35

Input area:

State Probability Asset I Asset II Asset III

Recession 0.15 0.20 0.20 0.05
Normal 0.35 0.15 0.10 0.10
Boom 0.35 0.10 0.15 0.15
Explosive 0.15 0.05 0.05 0.20

Output area:

Return Squared
a. Asset I Probability Return Product Deviation Deviation Product
Recession 0.15 0.20 0.0300 0.0750 0.00563 0.00084
Normal 0.35 0.15 0.0525 0.0250 0.00063 0.00022
Boom 0.35 0.10 0.0350 (0.0250) 0.00063 0.00022
Explosive 0.15 0.05 0.0075 (0.0750) 0.00563 0.00084
E(R) = 12.50% Variance = 0.00213

Standard Deviation = 4.61%

Return Squared
Asset II Probability Return Product Deviation Deviation Product
Recession 0.15 0.20 0.0300 0.0750 0.00563 0.00084
Normal 0.35 0.10 0.0350 (0.0250) 0.00063 0.00021875
Boom 0.35 0.15 0.0525 0.0250 0.00063 0.00021875
Explosive 0.15 0.05 0.0075 (0.0750) 0.00563 0.00084
E(R) = 12.50% Variance = 0.00213

Standard Deviation = 4.61%

Return Squared
Asset III Probability Return Product Deviation Deviation Product
Recession 0.15 0.05 0.0075 (0.0750) 0.00563 0.00084
Normal 0.35 0.10 0.0350 (0.0250) 0.00063 0.00022
Boom 0.35 0.15 0.0525 0.0250 0.00063 0.00022
Explosive 0.15 0.20 0.0300 0.0750 0.00563 0.00084
E(R) = 12.50% Variance = 0.00213

Standard Deviation = 4.61%

b. Relationship between Asset 1 and Asset 2

Asset 1 Asset 2
Probability Deviation Deviation Product
Recession 0.15 0.0750 0.0750 0.00084
Normal 0.35 0.0250 (0.0250) (0.00022)
Boom 0.35 (0.0250) 0.0250 (0.00022)
Explosive 0.15 (0.0750) (0.0750) 0.00084
Covaraince = 0.001250

Correlation = 0.5882
 Relationship between Asset 1 and Asset 3
Asset 1 Asset 3
Probability Deviation Deviation Product
Recession 0.15 0.0750 (0.0750) (0.00084)
Normal 0.35 0.0250 (0.0250) (0.00022)
Boom 0.35 (0.0250) 0.0250 (0.00022)
Explosive 0.15 (0.0750) 0.0750 (0.00084)
Covaraince = (0.002125)

Correlation = -1.0000

Relationship between Asset 2 and Asset 3

Asset 2 Asset 3
Probability Deviation Deviation Product
Recession 0.15 0.0750 (0.0750) (0.00084)
Normal 0.35 (0.0250) (0.0250) 0.00022
Boom 0.35 0.0250 0.0250 0.00022
Explosive 0.15 (0.0750) 0.0750 (0.00084)
Covaraince = (0.001250)

Correlation = -0.5882

c. Asset 1 and Asset 2 equally-weighted portfolio

E(R) = 12.50%

Variance = 0.0016875

Standard deviation = 4.11%

d. Asset 1 and Asset 3 equally-weighted portfolio

E(R) = 12.50%

Variance = 0.000000

Standard deviation = 0.00%

e. Asset 2 and Asset 3 equally-weighted portfolio

E(R) = 12.50%

Variance = 0.000438

Standard deviation = 2.09%

f. As long as the correlation between the returns on two securities is below 1, there is a benefit to diversification.
A portfolio with negatively correlated assets can achieve greater risk reduction than a portfolio with positively
correlated assets, holding the expected return on each Asset constant. Applying proper weights on perfectly
negatively correlated Assets can reduce portfolio variance to 0.
 Chapter 11
Question 36

Input area:

State Probability Stock A Stock B

Bust 0.15 (0.10) (0.08)
Normal 0.60 0.09 0.08
Boom 0.25 0.32 0.26

Amount Stock A's beta exceeds Stock B's beta 0.25

Output area:

a. Stock A Probability Return Product

Recession 0.15 (0.10) (0.0150)
Normal 0.60 0.09 0.0540
Boom 0.25 0.32 0.0800
E(R) = 11.90%

Stock B Probability Return Product

Recession 0.15 (0.08) (0.0120)
Normal 0.60 0.08 0.0480
Boom 0.25 0.26 0.0650
E(R) = 10.10%

b. Slope of SML 7.20% equals the market risk premium.

 Chapter 11
Question 37

Input area:

Stock A price today $ 75.00

Stock A price in one year: Probability:
Recession $ 64 20%
Normal $ 87 60%
Expanding $ 97 20%

Stock A correlation with market 0.70

Stock B E(R) 14%
Stock B standard deviation 34%
Stock B correlation with market 0.24
Stock B correlation with Stock A 0.36
Market standard deviation 18%
b. Weight of Stock A 70%

Output area:

Return Squared
a. Stock A Probability Return Product Deviation Deviation Product
Recession 0.20 (0.147) (0.0293) (0.2720) 0.07398 0.0148
Normal 0.60 0.160 0.0960 0.0347 0.00120 0.0007
Expanding 0.20 0.293 0.0587 0.1680 0.02822 0.0056
E(R) = 0.1253 Variance = 0.0212

Standard deviation 14.55%

Stock A beta 0.566

Stock B beta 0.453

b. Portfolio E(R) 12.97%

Portfolio variance 0.02825

Portfolio standard deviation 16.81%

c. Portfolio beta 0.532

Chapter 11
Question 38

Input Area:

Stock Expected return Standard deviation

A 9% 33%
B 15% 62%
Covariance 0.001

Output Area:

Weight of Stock A in minimum variance portfolio 0.7804

Weight of Stock B in minimum variance portfolio 0.2196

Portfolio E(R) 10.32%

Portfolio variance 0.0852

Portfolio standard deviation 29.19%