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    Capital Market Theory/Risk

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    1. These are the hypothetical returns during the past even years on a market portfolio of common stocks and a portfolio of Treasury bills.

    YEAR COMMON TREASURY BILLS
    STOCKS BILL

    -7 32.4% 11.2%
    -6 -4.9 14.7
    -5 21.4 10.5
    -4 22.5 8.8
    -3 63 9.9
    -2 32.2 7.7
    last 18.5 6.2

    The realized risk premium is the return on common stocks less the return on Treasury bills.
    a. Calculate the realized risk premium of common stocks over Treasury bills in each year.
    b. Calculate the average risk premium of common stocks over Trasury bills during the seven-year period.
    c. Is it possible for the observed risk premium to be negative?

    2. Four equally likely states of the economy may occur next year. Below are the returns
    on the stocks of Belinkie Enterprise and Overlake Company under each of the possible states.

    STATE BELINKIE OVERLAKE
    ENTERPRISES COMPANY

    1 0.04 0.05
    2 0.06 0.07
    3 0.09 0.10
    4 0.04 0.14

    a. What is the expected return on each stock?
    b. What is the variance of the returns on each stock?

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    Solution Preview

    2. Four equally likely states of the economy may occur next year. Below are the returns
    on the stocks of Belinkie Enterprise and Overlake Company under each of the possible states.

    STATE BELINKIE OVERLAKE
    ENTERPRISES COMPANY

    1 0.04 0.05
    2 0.06 0.07
    3 ...

    Solution Summary

    The capital market theory/risk for hypothetical returns.

    $2.19

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