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Predicting the Value of Two Stocks

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6) There are two stocks in the market, stock A and stock B. The price of stock A today is $75. The price of stock A next year will be $63 if the economy is in a recession, $83 if the economy is normal, and $96 if the economy is expanding. The probabilities of recession, normal times, and expansion are .2, .6, and .2 respectively. Stock A pays no dividends and has a correlation of .8 with the market portfolio. Stock B has an expected return of 13%, a standard deviation of 34%, a correlation with the market portfolio of .25, and a correlation with stock A of .48. The market portfolio has a standard deviation of 18%. Assume CAPM holds.

a. If you are a typical, risk adverse investor with a well-diversified portfolio, which of the stocks would you prefer to hold? Why?
b. What are the expected return and standard deviation of a portfolio consisting of 70% stock A and 30% of stock B?
c. What is the beta of the portfolio in part b.?

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6) There are two stocks in the market, stock A and stock B. The price of stock A today is $75. The price of stock A next year will be $63 if the economy is in a recession, $83 if the economy is normal, and $96 if the economy is expanding. The probabilities of recession, normal times, and expansion are .2, .6, and .2 respectively. Stock A pays no dividends and has a correlation of .8 with the market portfolio. Stock B has an expected return of 13%, a standard deviation of 34%, a correlation with the market portfolio of .25, and a correlation with stock A of .48. The market portfolio has a standard deviation of 18%. Assume CAPM ...

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The expert predicts the value of two stocks.

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Develop a regression model to predict the price of two stocks

The closing stock price for each of two stocks was recorded over a 12-month period. The closing price for the Dow Jones Industrial Average (DJIA) was also recorded over this same time period. These values are shown in the following table:

DJIA Stock 1 Stock 2
11,168 48.5 32.4
11,150 48.2 31.7
11,186 44.5 31.9
11,381 44.7 36.6
11,679 49.3 36.7
12,081 49.3 38.7
12,222 46.1 39.5
12,463 46.2 41.2
12,622 47.7 43.3
12,269 48.3 39.4
12,354 47.0 40.1
13,063 47.9 42.1
13,326 47.8 45.2

(a) Develop a regression model to predict the price of stock 1 based on the Dow Jones Industrial Average.

(b) Develop a regression model to predict the price of stock 2 based on the Dow Jones Industrial Average.

(c) Which of the two stocks is most highly correlated to the Dow Jones Industrial Average over this time period?

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