FIN515 Week 5 Problem Set Solutions
10-4. You bought a stock one year ago for $50 per share and sold it today for $55 per share. It paid a $1 per share dividend today.
a. What was your realized return?
b. How much of the return came from dividend yield and how much came from capital gain?
Compute the realized return and dividend yield on this equity investment.
a.
b. 10-20. Consider two local banks. Bank A has 100 loans outstanding, each for $1 million, that it expects will be repaid today. Each loan has a 5% probability of default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has only one loan of $100 million outstanding, which it also expects will be repaid today. It also has a 5% probability of not being repaid. Explain the difference between the type of risk each bank faces. Which bank faces less risk? Why?
The expected payoffs are the same, but bank A is less risky. (See solution to Problem 10–21 for full explanation of the banks’ relative risk levels.)
10-22. Consider the following two, completely separate, economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move together—in good times all prices rise together and in bad times they all fall together. In the second economy, stock returns are independent—one stock increasing in price has no effect on the prices of other stocks. Assuming you are risk-averse and you could choose one of the two economies in which to invest, which one would you choose? Explain.
A risk-averse investor would choose the economy in which stock returns are independent because this risk can be diversified away in a large portfolio.
10-30. What does the beta of a stock measure?
Beta measures the amount of systemic risk in a stock
10-35. Suppose the market risk premium is 5% and the risk-free interest rate is 4%. Using the data in Table 10.6, calculate the expected return of investing in
a. Starbucks’ stock.
b. Hershey’s stock.
c.
a. What was your realized return?
b. How much of the return came from dividend yield and how much came from capital gain?
Compute the realized return and dividend yield on this equity investment.
a.
b. 10-20. Consider two local banks. Bank A has 100 loans outstanding, each for $1 million, that it expects will be repaid today. Each loan has a 5% probability of default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has only one loan of $100 million outstanding, which it also expects will be repaid today. It also has a 5% probability of not being repaid. Explain the difference between the type of risk each bank faces. Which bank faces less risk? Why?
The expected payoffs are the same, but bank A is less risky. (See solution to Problem 10–21 for full explanation of the banks’ relative risk levels.)
10-22. Consider the following two, completely separate, economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move together—in good times all prices rise together and in bad times they all fall together. In the second economy, stock returns are independent—one stock increasing in price has no effect on the prices of other stocks. Assuming you are risk-averse and you could choose one of the two economies in which to invest, which one would you choose? Explain.
A risk-averse investor would choose the economy in which stock returns are independent because this risk can be diversified away in a large portfolio.
10-30. What does the beta of a stock measure?
Beta measures the amount of systemic risk in a stock
10-35. Suppose the market risk premium is 5% and the risk-free interest rate is 4%. Using the data in Table 10.6, calculate the expected return of investing in
a. Starbucks’ stock.
b. Hershey’s stock.
c.