Financial Managerial Essay Example
Tutorial 1: Risk and Return
1. Expected return. A stock’s returns have the following distribution: Demand for the company’s product | Probability of this demand occurring | Rate of return if this demand occurs | Weak | 0.1 | (50%) | Below average | 0.2 | (5%) | Average | 0.4 | 16 | Above average | 0.2 | 25 | strong | 0.1 | 60 | | 1.0 | | Calculate the stock’s expected return, standard deviation, and the coefficient of variation. 2. Required rate of return. Stock R has a beta of 1.5, Stock S has a beta of 0.75, the expected rate of return on an average stock is 13%, and the risk free rate is 7%. By how much does the required return on the riskier stock exceed the required return on the less risky stock?
3. Required rate of return. Suppose rRF =9%, rM = 14% and bi = 1.3 a. What is ri, the required return on stock i? b. Now suppose rRF (1) increases to 10% or (2) decreases to 8%. The slope of the SML remains constant. How would this affect rM and ri? c. Now assume rRF remains at 9%, but rM (1) increases to 16% or (2) falls to 13%. The slope of the SML does not remain constant. How would this affect ri?
4. Evaluating risk and return. Stock X has an expected return of 10%, a beta coefficient of 0.9, and a 35% standard deviation of expected return. Stock Y has a 12.5% expected return, a beta coefficient of 1.2, and a 25% standard deviation. The risk free rate is 6%, and the market risk premium is 5%.
a. Calculate each stock’s coefficient of variation. b. Which stock is riskier for a diversified investor? c. Calculate each stock’s required rate of return. d. On the basis of the two stocks’ expected and required returns, which stock will be more attractive to a diversified investor?
1. Expected return. A stock’s returns have the following distribution: Demand for the company’s product | Probability of this demand occurring | Rate of return if this demand occurs | Weak | 0.1 | (50%) | Below average | 0.2 | (5%) | Average | 0.4 | 16 | Above average | 0.2 | 25 | strong | 0.1 | 60 | | 1.0 | | Calculate the stock’s expected return, standard deviation, and the coefficient of variation. 2. Required rate of return. Stock R has a beta of 1.5, Stock S has a beta of 0.75, the expected rate of return on an average stock is 13%, and the risk free rate is 7%. By how much does the required return on the riskier stock exceed the required return on the less risky stock?
3. Required rate of return. Suppose rRF =9%, rM = 14% and bi = 1.3 a. What is ri, the required return on stock i? b. Now suppose rRF (1) increases to 10% or (2) decreases to 8%. The slope of the SML remains constant. How would this affect rM and ri? c. Now assume rRF remains at 9%, but rM (1) increases to 16% or (2) falls to 13%. The slope of the SML does not remain constant. How would this affect ri?
4. Evaluating risk and return. Stock X has an expected return of 10%, a beta coefficient of 0.9, and a 35% standard deviation of expected return. Stock Y has a 12.5% expected return, a beta coefficient of 1.2, and a 25% standard deviation. The risk free rate is 6%, and the market risk premium is 5%.
a. Calculate each stock’s coefficient of variation. b. Which stock is riskier for a diversified investor? c. Calculate each stock’s required rate of return. d. On the basis of the two stocks’ expected and required returns, which stock will be more attractive to a diversified investor?