HOMEWORK 9

8-4 EXPECTED AND REQUIRED RATES OF RETURN Assume that the risk-free rate is 3.5% and the
market risk premium is 4%. What is the required return for the overall stock market? What is the required
rate of return on a stock with a beta of 0.8?
RPM = rM – rRF
4% = rM – 3.5%
rM = 7.5%
ri = rRF + RPM x bi = 3.5% + 4% x 0.8 = 6.7%

8-5 BETA AND REQUIRED RATE OF RETURN A stock has a required return of 9%, the risk-free rate is
4.5%, and the market risk premium is 3%.
a. What is the stock’s beta?
bi = (ri - rRF) / RPM = (9% - 4.5%) / 3% = 1.5
b. If the market risk premium increased to 5%, what would happen to the stock’s required rate of return?
Assume that the risk-free rate and the beta remain unchanged
bi = (ri - rRF) / RPM
1.5 = (ri - 4.5%) / 5%
ri = 12%

8-8 BETA COEFFICIENT Given the following information, determine the beta coefficient for Stock L that
is consistent with equilibrium: rL = 10.5%; rRF = 3.5%; rM = 9.5%.
RPM = rM – rRF = 9.5% - 3.5% = 6%
bi = (ri - rRF) / RPM = (10.5% - 3.5%) / 6% = 1.17

8-10 CAPM AND REQUIRED RETURN Beale Manufacturing Company has a beta of 1.1, and Foley
Industries has a beta of 0.30. The required return on an index fund that holds the entire stock market is
11%. The risk-free rate of interest is 4.5%. By how much does Beale’s required return exceed Foley’s
required return?
Beale Manufacturing Company Foley Industries
bi 1.1 0.30
rM 11% 11%
rRF 4.5% 4.5%
ri 11.65% 6.45%
Therefore, Beale’s required return exceed Foley’s required return by 5.2%.
8-13 CAPM, PORTFOLIO RISK, AND RETURN Consider the following information for Stocks A, B, and
C. The returns on the three stocks are positively correlated, but they are not perfectly correlated. (That is,
each of the correlation coefficients is between 0 and 1.)
Fund P has one-third of its funds invested in each of the three stocks. The risk-free rate is 5.5%, and the
market is in equilibrium. (That is, required returns equal expected returns.)
a. What is the market risk premium (rM - rRF)?
ri = rRF + RPM x bi
9.55% = 5.5% + RPM x 0.9
RPM = $4.50
b. What is the beta of Fund P?
Average of beta = ( 0.9 +1.1 + 1.6) / 3 = 1.20
c. What is the required return of Fund P?
ri = rRF + RPM x bi
ri = 5.5 + 4.50 x 1.20
ri = 10.9 %
d. Would you expect the standard deviation of Fund P to be less than 15%, equal to 15%, or greater than
15%? Explain.
If the correlation coefficient of portfolio shall be 1. In this situation unsystematic risk can not be
diversified. So, The standard deviation of the fund P is equal to 15%.
If the correlation coefficient of portfolio shall be range of 0 to 1. In this situation unsystematic risk can be
little bit diversified. So, The standard deviation of the fund P should be less than 15%.

8-14 PORTFOLIO BETA Suppose you held a diversified portfolio consisting of a $7,500 investment in each
of 20 different common stocks. The portfolio’s beta is 1.25. Now suppose you decided to sell one of the
stocks in your portfolio with a beta of 1.0 for $7,500 and use the proceeds to buy another stock with a beta
of 0.80. What would your portfolio’s new beta be?
New beta = (1.25 x 20 – 1.0 + 0.80) / 20 = 1.24

8-15 CAPM AND REQUIRED RETURN HR Industries (HRI) has a beta of 1.6; LR Industries’s (LRI) beta
is 0.8. The risk-free rate is 6%, and the required rate of return on an average stock is 13%. The expected
rate of inflation built into rRF falls by 1.5 percentage points, the real risk-free rate remains constant, the
required return on the market falls to 10.5%, and all betas remain constant. After all of these changes, what
will be the difference in the required returns for HRI and LRI?
New rRF = 6% - 1.5% = 4.5%
New rM = 10.5%
RPM = rM – rRF = 10.5% - 4.5% = 6%
rHRI = rRF + RPM x bHRI = 4.5% + 6% x 1.6 = 14.1%
rLRI = rRF + RPM x bLRI = 4.5% + 6% x 0.8 = 9.3%
The difference in the required returns for HRI and LRI is = 14.1% - 9.3% = 4.8%