Risk, Return, and the Capital Asset Pricing Model

1. An investment has a 20% chance of producing a 25% return, a 60% chance of producing a 10% return, and
a 20% chance of producing a -15% return. What is its expected return? What is its standard deviation?
2. A stock’s returns for the past 3 years were 10%, −15%, and 35%. What is the historical average return?
What is the historical sample standard deviation?
3. A stock’s return has the following distribution:
Demand for Probability of this Rate of return if this
company's products demand occurring demand occurs
Weak 0.1 -50%
below average 0.2 -5%
average 0.4 16%
above average 0.2 25%
Strong 0.1 60%
Calculate the stock’s expected return, standard deviation, and coefficient of variation.
4. AA Corporation’s stock has a beta of 0.8. The risk-free rate is 4% and the expected return on the market is
12%. What is the required rate of return on AA’s stock?
5. Suppose that the risk-free rate is 5% and that the market risk premium is 7%. What is the required return on
(1) the market, (2) a stock with a beta of 1.0, and (3) a stock with a beta of 1.7?
6. As an equity analyst you are concerned with what will happen to the required return to Universal Toddler’s
stock as market conditions change. Suppose rRF = 5%, rM = 12%, βUT =1.4. Under current conditions, what
is rUT, the required rate of return on UT stock?
7. Suppose rRF = 5%, rM =10%, and rA =12%. Calculate Stock A’s beta. Also, if Stock A’s beta were 2.0, then
what would be A’s new required rate of return?
8. An individual has $35,000 invested in a stock with a beta of 0.8 and another $40,000 invested in a stock
with a beta of 1.4. If these are the only two investments in her portfolio, what is her portfolio’s beta?
9. Your investment club has only two stocks in its portfolio. $20,000 is invested in a stock with a beta of 0.7,
and $35,000 is invested in a stock with a beta of 1.3. What is the portfolio’s beta?
10. An investor has a three-stock portfolio with $25,000 invested in Apple, $50,000 invested in Ford, and
$25,000 invested in Walmart. Apple’s beta is estimated to be 1.20, Ford’s beta is estimated to be 0.80, and
Walmart’s beta is estimated to be 1.0. What is the estimated beta of the investor’s portfolio?
11. Suppose you manage a $4 million fund that consists of four stocks with the following investments:
Stock Investment beta
A $400,000 1.5
B $600,000 -0.5
C $1,000,000 1.25
D $2,000,000 0.75
If the market’s required rate of return is 14% and the risk-free rate is 6%, what is the fund’s required rate of
return?
12. Please find the following data and calculate the value of ‘beta’ for both the companies:
Market Microdrive Snaildrive
Standard deviation
(annual) 19.89% 51.75% 34.17%
Correlation with market 0.511 0.264
beta ? ?
13. Please find the following data and calculate the value of ‘beta’ for both the companies:
Market Microdrive Snaildrive
Variance (annual) 0.0396 0.2678 0.1168
Covariance with market 0.0526 0.0179
beta ? ?
14. Your retirement fund consists of a $5,000 investment in each of 15 different common stocks. The portfolio’s
beta is 1.20. Suppose you sell one of the stocks with a beta of 0.8 for $5,000 and use the proceeds to buy
another stock whose beta is 1.6. Calculate your portfolio’s new beta.
15. Suppose you hold a diversified portfolio consisting of a $7,500 investment in each of 20 different common
stocks. The portfolio’s beta is 1.12. Now, suppose you sell one of the stocks with a beta of 1.0 for $7,500
and use the proceeds to buy another stock whose beta is 1.75. Calculate your portfolio’s new beta.
16. The spreadsheet problem that was solved in the class (Short questions like finding the portfolio
risk/return/CV/Sharpe ratio/Treynor ratio etc.)