Question

1.Here are data on two companies. The T-bill rate is 4% and the market risk premium is 6%.

Answer 1

Answer:

Explanation:

1.

According to the CAPM model

Fair return = Risk-free rate of return + (Beta × Market Premium)

For $1 discount store:

Expected return = 4% +(1.5 × 6%)

Expected return = 0.04 + (1.5 × 0.06)

Expected return = 0.04 + 0.09

Expected return = 0.13

Expected return = 13%

For everything $5

Expected Return = 4% + (1 × 6%)

Expected return =  0.04 + (1 × 0.06)

Expected return = 0.04 + 0.06

Expected return = 0.10

Expected return = 10%

2.

From the above calculation;

For $1 discount store:

Since the expected return is greater than the forecasted return at 12%.

Thus, it is overpriced.

For everything $5

Here, it is obvious from the above calculation that the expected return is lesser than the forecasted return at 11%.

Therefore, it is underpriced.

3) Beta can be defined as the security change that takes place due to market functuations. Thus, Beta manages the systematic risk associated with firms. From the information given, Kaskin Inc. has a more systematic risk(beta) than Quinn Inc. Thus, option A is the most accurate.

4)

To first find the growth rate by using CAPM model.

Required return = Risk free return + $\beta$ (market return - risk free return)

Required return = 0.08 + 1(0.18 - 0.08)

Required return = 18%

Using the formula:

Required return = (next year dividend/current price) + growth rate

18% = (9/100) + g

0.18 = 0.09 g

g = 0.09

Growth rate g = 9%

To determine the price at year 1; we have:

= $year \ 1 \ dividend \times \dfrac{1+g}{ke-g}$

$= 9 \times \dfrac{1+0.09}{0.18 - 0.09}$

= $109.00

Therefore, the investor can earn a profit of $9 after selling the stock for $109 at the end of the year 1.

5.

According to beta

For portfolio A.

Risk premium per unit = (21 - 8)%/1.3

Risk premium per unit = (0.21 - 0.08)/1.3

Risk premium per unit = 0.1

Risk premium per unit = 10%

For portfolio B.

Risk premium per unit = (17 - 8)%/0.7

Risk premium per unit = (0.17 - 0.08)/0.7

Risk premium per unit = 0.1286

Risk premium per unit = 12.86%

From above, it is clear that the risk associated with portfolio B is lesser compared to portfolio A.

Thus; the correct option is b. A; B