FINM 2412 Financial Management for Business
Tutorial 9 Questions
Question 1
The risk-free rate is 7% p.a. The expected return on the market portfolio is 12% p.a., and the variance
of this return is 0.09.
You are examining two stocks: A and B. The standard deviations of the returns on Stocks A and B are
50% p.a. and 20% p.a. respectively. The correlation between each stock and the market is:
.
a. Calculate the beta of each stock.
b. Calculate the expected return of each stock.
c. You construct a portfolio with 60% of your money in Stock A and 40% in Stock B. What is the
beta of this portfolio? What is the expected return of this portfolio?
Hint: The beta of Stock A is equal to its covariance with the market divided by the variance of the
market:
Hint: Covariance is a function of the standard deviation of each asset and the correlation between
them.
Question 2
In the following table, X, Y, and Z refer to stocks, while M refers to the market portfolio. The
following partially complete information is available:
Standard Expected Covariance between
Deviation Return Stock and Market
X 0.1 ? 0.01
Y 0.2 ? 0.025
Z ? 0.216 0.052
M 0.1414 0.120 n/a
The correlation between Stocks X and Y is 0.60.
Required
1
a. Calculate the betas of Stocks X and Y.
b. Calculate the beta of a new portfolio comprising 80% in X and 20% in Y.
c. What is the risk-free rate of return?
d. What is the expected return on the new portfolio in (b)?
Question 3
Consider a CAPM economy in which the risk-free rate is 4%, the expected return on the market
portfolio is 11% and the standard deviation of the market portfolio is 15%.
a. What is the most efficient way of investing if you require a return of 10% p.a.? In this case,
what risk would you be bearing?
b. How would you invest to earn the highest possible expected return while limiting your risk to
a standard deviation of 12%?
Question 4
Suppose a company uses only debt and internal equity to finance its capital budget and uses CAPM to
compute its cost of equity. Company estimates that its WACC is 12%. The capital structure is 75%
debt and 25% internal equity. Before tax cost of debt is 12.5% and tax rate is 20%. Risk free rate is
6% and market risk premium is 8%. What is the beta of the company?
