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Risk and Return Finance

1. Suppose the expected return and variance of the market portfolio are 0.15 and 0.002 respectively. If the riskless return is 0.055, what will be the required return on a stock whose return variance is 0.12 and correlation with the market portfolioâ??s return is 0.6?

2. PAB Inc. is evaluating whether to invest in a new security or to purchase a one-year Treasury bill that is currently paying 9.5%. The security has the following probability of outcomes:






a. Calculate the security's expected return and standard deviation.

b. Should PAB invest in the security? Why or why not?

3. Xerox has a 8.5% coupon bond that has a remaining maturity of 16 years. The bond is callable in three years at a price of $1,100. Its current market price is $1,250.

a. If the required return for this bond is 10% (assuming itâ??s not callable), what is the value of the bond?

b. What is the yield to maturity (based on the current market price)?

c. What is the yield to call?

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Solution Preview

Given that,
Expected return of the market portfolio=0.15
Variance of the market portfolio=0.002
Risk free return=0.055
Variance of the stock=0.12
Correlation coefficient with the market portfolio=0.6

Beta of the stock=(0.6*(0.002)^(1/2)*(0.12)^(1/2))/0.002=4.65

We have,
Risk free rate=9.5%
Probability Return
0.15 6%
0.30 9%
0.40 10%
0.15 15%

The expected return of the company PAB Inc. is:
Expected return=0.15*6%+0.30*9%+0.40*10%+0.15*15%=0.0985=9.85%

Standard ...

Solution Summary

The risk and return finance is examined. The probability and return is examined.