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    Expected Return and Beta Risk

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    17. The expected return on the market is 13% and the risk-free rate is 5%. Your portfolio has a beta of 1.3. What is the expected return on your portfolio?

    18. What is the beta of the following portfolio?

    40% Stock A Beta = 1.2
    30% Stock B Beta = 1
    30% Stock C Beta = 0.9

    19. The more ________________________ the covariance of two assets, the greater the benefits of diversification.

    20. The risk-free rate is 6% and the expected return on the market is 12%. Which of the following stocks is most undervalued?

    Stock A Expected Return = 11% Beta = 1.5

    Stock B Expected Return = 11% Beta = 0.5

    21. You have taken a job with an arbitrage firm. An analyst has presented the following information to you.

    Stock A Expected Return is 12%

    Stock B Expected Return is 15%.

    As arbitrage trader what action would you take?

    25. Total Risk is comprised of ___________________ + _______________________.

    26. ______________________________ can be largely diversified away.

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    Solution Preview

    17. The expected return on the market is 13% and the risk-free rate is 5%. Your portfolio has a beta of 1.3. What is the expected return on your portfolio?

    Expected Return, using CAPM = Risk Free Rate + (Market return - Risk free rate) X beta
    Expected Return = 5% + (13%-5%) X 1.3 = 15.4%

    18. What is the beta of the following portfolio?

    40% Stock A Beta = 1.2
    30% Stock B Beta = 1
    30% Stock C Beta = 0.9

    The beta of a portfolio is the weighted average beta of the individual stocks
    beta of portfolio = 1.2X0.4 + 1X0.3 + 0.9X0.3 = 1.05

    19. The ...

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