1. Suppose we have one risky asset Stock I and a risk-free asset. Stock I has...

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Finance

1. Suppose we have one riskyasset Stock I and a risk-free asset. Stock I has an expected returnof 25% and a beta of 2. The risk-free asset’s return is6%.                                                                                                                                   (15 marks total)
a.   Calculate theexpected returns and betas on portfolios with x% invested in StockI and the rest invested in the risk-free asset, where x% = 0%, 25%,75%, 100%, 125%, and 150%.
b.   Whatreward-to-risk ratio does Stock I offer? How do you interpret thisratio?                                                                                                                 (1.5 marks)
c.   Suppose we havea second risky asset, Stock J. Stock J has an expected return of20% and a beta of 1.7. Calculate the expected returns and betas onportfolios with x% invested in Stock J and the rest invested in therisk-free asset, where x% = 0%, 25%, 75%, 100%, 125%, and 150%.
d.   Whatreward-to-risk ratio does Stock J offer? How do you interpret thisratio?                                                                                                                 (1.5 marks)
e.   Plot theportfolio betas against the portfolio expected returns for Stock Ion a graph, and link all the points together with a line. Then plotthe portfolio betas against the portfolio expected returns forStock J on the same graph, and link all these points together withanother line. (This can be done easily with the charting functionin Microsoft Excel.)
f.   Use the graphin part (e) above, together with your answers to parts (b) and (d)above to explain why Stock J is an inferior investment to StockI.
g.   Can a situationin which one stock is inferior to another stock persist in awell-organized, active market? Why or whynot?

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3.7 Ratings (555 Votes)

a Expected returns and betas of portfolios i Where x 0 It implies that entire amount is invested in Risk free asset Weight of investment in risk free asset 1 and weight in stock I 0 Therefore expected return 6 1 25 0 6 Beta of Stock I 2 and beta of risk free asset 0 Because risk free assets beta are always zero as the risk is zero Beta of the portfolio 0 1 2 0 0 ii where x 25 It implies that 75 is invested in Risk free asset Weight of investment in risk free asset 075 and weight in stock I 025 Therefore expected return 6 075 25 025 1075 Beta of Stock I 2 and beta of risk free asset 0 Because risk free assets beta are always zero as the risk is zero Beta of the portfolio 0 075 2 025 050 iii where x 75 It implies that 25 is invested in Risk free asset Weight of investment in risk free asset 025 and weight in stock I 075 See Answer

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1. Suppose we have one riskyasset Stock I and a risk-free asset. Stock I has an expected returnof 25% and a beta of 2. The risk-free asset’s return is6%. (15 marks total)a. Calculate theexpected returns and betas on portfolios with x% invested in StockI and the rest invested in the risk-free asset, where x% = 0%, 25%,75%, 100%, 125%, and 150%. b. Whatreward-to-risk ratio does Stock I offer? How do you interpret thisratio? (1.5 marks)c. Suppose we havea second risky asset, Stock J. Stock J has an expected return of20% and a beta of 1.7. Calculate the expected returns and betas onportfolios with x% invested in Stock J and the rest invested in therisk-free asset, where x% = 0%, 25%, 75%, 100%, 125%, and 150%. d. Whatreward-to-risk ratio does Stock J offer? How do you interpret thisratio? (1.5 marks)e. Plot theportfolio betas against the portfolio expected returns for Stock Ion a graph, and link all the points together with a line. Then plotthe portfolio betas against the portfolio expected returns forStock J on the same graph, and link all these points together withanother line. (This can be done easily with the charting functionin Microsoft Excel.) f. Use the graphin part (e) above, together with your answers to parts (b) and (d)above to explain why Stock J is an inferior investment to StockI. g. Can a situationin which one stock is inferior to another stock persist in awell-organized, active market? Why or whynot?