Introduction to Finance HW#4

1. (50 points) Complete “Homework #4: 50%” on MyFinanceLab under “Assignments.” Students can try each question up to three times. Excel may be used to solve some of the problems (e.g., you may use Excel to find standard deviation of stock returns.)

1. (30 points) Jane Warren is considering building a portfolio containing two assets, L and M. Asset L will represent 40% of the dollar value of the portfolio, and asset M will account for the other 60%. The expected returns over the next 6 years, 2012-2017, for each of these assets, are shown in the following table. (Please use the Excel template posted on Canvas under “AssignmentsàHW4àHW4 Excel Example and Template.” An example can be found in the same Excel document.)

 Expected Return Year Asset L Asset M 2012 14% 20% 2013 14 18 2014 16 16 2015 17 14 2016 17 12 2017 19 10

1. Calculate the expected portfolio return, kp, for each of the 6 years.
2. Calculate the expected value of portfolio return, , over the 6-year period.
3. Calculate the standard deviation of expected portfolio returns, ,over the 6-year period.
4. How would you characterize the correlation of returns of the two assets L and M?
5. Discuss any benefits of diversification achieved through creation of the portfolio.

1. (20 points) Use the basic equation for the capital asset pricing model (CAPM) to work each of the following problems.

1. A stock has a beta of 1.2, the expected return on the market is 14 percent, and the risk-free rate is 5.2 percent. What must the expected return on this stock be?
2. A stock has an expected return of 13 percent, the risk-free rate is 4.5 percent, and the market risk premium is 7 percent. What must the beta of this stock be?
3. A stock has an expected return of 12 percent, its beta is .70, and the risk-free rate is 5.5 percent. What must the expected return on the market be?
4. A stock has an expected return of 15 percent, its beta is 1.45, and the expected return on the market is 12 percent. What must be risk-free rate be?