CAPM, Bonds
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1. Calculate the required rate of return for Mercury Inc., assuming that investors expect 5% rate of inflation in the future. The real risk-free rate is equal to 3% and the market risk premium is 5%. Mercury has a beta of 2.0, and its realized rate of return has averaged 15% over the last 5 years.
2. A stock has an expected return of 12.25%. The beta of the stock is 1.15 and the risk-free rate is 5%. What is the market risk premium?
3. An annual coupon bond with a $1,000 face value matures in 10 years. The bond currently sells for $903.7351 and has a 9% yield to maturity. What is the bond's annual coupon rate?
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Solution Summary
Answers 3 questions:
1) Calculates the required rate of return for Mercury Inc. using CAPM.
2) Calculates market risk premium using CAPM.
3) Calculates bond's annual coupon rate given price and yield to maturity.
Solution Preview
1. Calculate the required rate of return for Mercury Inc., assuming that investors expect 5% rate of inflation in the future. The real risk-free rate is equal to 3% and the market risk premium is 5%. Mercury has a beta of 2.0, and its realized rate of return has averaged 15% over the last 5 years.
risk free rate = real risk free rate + inflation =3% + 5% = 8%
(r m - r f) = market risk premium= 5%
Therefore r m = 13% =8%+5%
CAPM (Capital Asset Pricing Model equation is:
r A= r f + βA (r m - r f)
risk free rate= r f = 8%
beta ...
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