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Important Information about Beta and Required Return

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The riskless return is currently 6%, and Chicago Gear has estimated the contingent returns given here.
State of the Market Probability that state Occurs Stock Market Chicago Gear
Stagnant 0.20 -10% -15% 9.75% 15.00%
Slow growth 0.35 10% 15%
Average growth 0.30 15% 25%
Rapid growth 0.15 25% 35%

A. Calculate the expected returns on the stock market and on Chicago Gear stock.

B. What is Chicago Gear's beta?

C. What is Chicago Gear's required return according to the CAPM?

(see attached spreadsheet)

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The riskless return is currently 6%, and Chicago Gear has estimated the contingent returns given here.

State of the Market Probability that state Occurs Stock Market Chicago Gear
Stagnant 0.20 -10% -15% 9.75% 15.00%
Slow growth 0.35 10% 15%
Average growth 0.30 15% 25%
Rapid growth 0.15 25% 35%

A. Calculate the expected returns on the stock market and on Chicago Gear stock.

Chicago Gear

Chicago Gear
return Probability return x Probability Difference from mean, i.e.15.% Difference 2 Prob x Difference 2
-15.00% 0.2 ...

Solution Summary

Calculates expected return on a stock and the market (given the probability distribution of return for the stock and the market), the stock's beta and the expected return on the stock according to the Capital Asset Pricing Model (CAPM).

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Important Information About Expected Returns and Betas for Investment Selection

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You have been scouring The Wall Street Journal looking for stocks that are "good values" and have calculated the expected returns for five stocks. Assume the risk-free rate (rRF) is 7 percent and the market risk premium (rM - rRF) is 2 percent. Which security would be the best investment? (Assume you must choose just one).

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