ESSEC BBA
Finance II
Part 2
Problem Set
The following problems are from the book “Corporate Finance” by Berk and DeMarzo.
1 You bought a stock one year ago for $50 per share. It paid a $1 per share dividend today. You sold it today for $55
per share.
a. What was your realized return?
b. How much of the return came from dividend yield and how much came from capital gain?
2 Repeat Problem 1 assuming that the stock fell $5 to $45 instead.
a. Is your capital gain different? Why or why not?
b. Is your dividend yield different? Why or why not?
3 Using the data in the following table, calculate the return for investing in Boeing stock from January 2, 2003, to
January 2, 2004, and also from January 2, 2008, to January 2, 2009, assuming all dividends are reinvested in the stock
immediately.
4 The last four years of returns for a stock are as follows:
a. What is the average annual return?
b. What is the variance of the stock’s returns?
c. What is the standard deviation of the stock’s returns?
5 You own three stocks: 1000 shares of Apple Computer, 10,000 shares of Cisco Systems, and 5000 shares of Goldman
Sachs Group. The current share prices and expected returns of Apple, Cisco, and Goldman are, respectively, $125,
$19, $120 and 12%, 10%, 10.5%.
a. What are the portfolio weights of the three stocks in your portfolio?
b. What is the expected return of your portfolio?
6 Consider a world that only consists of the three stocks shown in the following table:
a. Calculate the total value of all shares outstanding currently.
b. What fraction of the total value outstanding does each stock make up?
c. You hold the market portfolio, that is, you have picked portfolio weights equal to the answer to part b (that is,
each stock’s weight is equal to its contribution to the fraction of the total value of all stocks). What is the expected
return of your portfolio?
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11-11. Suppose Wesley Publishing’s stock has a volatility of 60%, while Addison Printing’s stock has a volatility of 30%. If
the correlation between these stocks is 25%, what is the volatility of the following portfolios of Addison and Wesley:
(a) 100% Addison, (b) 75% Addison and 25% Wesley, and (c) 50% Addison and 50% Wesley.
For Problems 22–24, suppose Johnson & Johnson and the Walgreen Company have expected returns and volatilities shown below,
with a correlation of 22%.
11-22. Calculate (a) the expected return and (b) the volatility (standard deviation) of a portfolio that is equally invested in
Johnson & Johnson’s and Walgreen’s stock.
11-23. For the portfolio in Problem 22, if the correlation between Johnson & Johnson’s and Walgreen’s stock were to
increase,
a. Would the expected return of the portfolio rise or fall?
b. Would the volatility of the portfolio rise or fall?
11-24. Calculate (a) the expected return and (b) the volatility (standard deviation) of a portfolio that consists of a long
position of $10,000 in Johnson & Johnson and a short position of $2000 in Walgreen’s.
11-30. You have $10,000 to invest. You decide to invest $20,000 in Google and short sell $10,000 worth of Yahoo! Google’s
expected return is 15% with a volatility of 30% and Yahoo!’s expected return is 12% with a volatility of 25%. The
stocks have a correlation of 0.9. What is the expected return and volatility of the portfolio?
11-26. A hedge fund has created a portfolio using just two stocks. It has shorted $35,000,000 worth of Oracle stock and has
purchased $85,000,000 of Intel stock. The correlation between Oracle’s and Intel’s returns is 0.65. The expected
returns and standard deviations of the two stocks are given in the table below:
a. What is the expected return of the hedge fund’s portfolio?
b. What is the standard deviation of the hedge fund’s portfolio?
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11-32. Suppose you have $100,000 in cash, and you decide to borrow another $15,000 at a 4% interest rate to invest in the
stock market. You invest the entire $115,000 in a portfolio J with a 15% expected return and a 25% volatility.
a. What is the expected return and volatility (standard deviation) of your investment?
b. What is your realized return if J goes up 25% over the year?
c. What return do you realize if J falls by 20% over the year?
12-1. Suppose Pepsico’s stock has a beta of 0.57. If the risk-free rate is 3% and the expected return of the market portfolio
is 8%, what is Pepsico’s equity cost of capital?
12-2.a Suppose the market portfolio has an expected return of 10% and a volatility of 20%, while Microsoft’s stock has a
volatility of 30%. Given its higher volatility, should we expect Microsoft to have an expected return that is higher than
10%?
12-4. Suppose all possible investment opportunities in the world are limited to the five stocks listed in the table below. What
does the market portfolio consist of (what are the portfolio weights)?
12-5. Using the data in Problem 4, suppose you are holding a market portfolio, and have invested $12,000 in Stock C.
a. How much have you invested in Stock A?
b. How many shares of Stock B do you hold?
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Some other problems (not from Berk and DeMarzo book):
Problem 1
Consider a world that only consists of the three stocks shown in the following table:
a. Calculate the total value of all shares outstanding currently.
b. What fraction of the total value outstanding does each stock make up?
c. You hold the market portfolio, that is, you have picked portfolio weights equal to the answer to part b (that is, each stock’s
weight is equal to its contribution to the fraction of the total value of all stocks). What is the expected return of your
portfolio?
Problem 2
Suppose the risk-free return is 4% and the market portfolio has an expected return of 10% and a volatility of 16%. Johnson
and Johnson Corporation (Ticker: JNJ) stock has a 20% volatility and a correlation with the market of 0.06.
a. What is Johnson and Johnson’s beta with respect to the market?
b. Under the CAPM assumptions, what is its expected return?
Problem 3
Consider a portfolio consisting of the following three stocks:
The volatility of the market portfolio is 10% and it has an expected return of 8%. The risk-free rate is 3%.
a. Compute the beta and expected return of each stock.
b. Using your answer from part a, calculate the expected return of the portfolio.
c. What is the beta of the portfolio?
d. Using your answer from part c, calculate the expected return of the portfolio and verify that it matches your answer to
part b.
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Problem 4
Suppose Intel stock has a beta of 2.16, whereas Boeing stock has a beta of 0.69. If the risk-free interest rate is 4% and the
expected return of the market portfolio is 10%, what is the expected return of a portfolio that consists of 60% Intel stock and
40% Boeing stock, according to the CAPM?
