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    Muqaddas Zulfiqar 30101assignment 7

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    Muqaddas Zulfiqar
    - The student calculated the expected return and standard deviation for a stock based on possible returns and probabilities of occurrence. The expected return was 20% and the standard deviation was 16.43%. - Using the CAPM model, the student calculated the required rate of return for a stock as 15.25% based on the stock's beta, risk-free rate, and expected market return. The present stock price was then calculated as $38.10. - The student calculated the expected return as 10.19% and standard deviation as 7.31% for an investment based on states of the economy, probabilities and rates of return for each state.

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    Muqaddas Zulfiqar 30101assignment 7

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    - The student calculated the expected return and standard deviation for a stock based on possible returns and probabilities of occurrence. The expected return was 20% and the standard deviation was 16.43%. - Using the CAPM model, the student calculated the required rate of return for a stock as 15.25% based on the stock's beta, risk-free rate, and expected market return. The present stock price was then calculated as $38.10. - The student calculated the expected return as 10.19% and standard deviation as 7.31% for an investment based on states of the economy, probabilities and rates of return for each state.

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    - The student calculated the expected return and standard deviation for a stock based on possible returns and probabilities of occurrence. The expected return was 20% and the standard deviation was 16.43%. - Using the CAPM model, the student calculated the required rate of return for a stock as 15.25% based on the stock's beta, risk-free rate, and expected market return. The present stock price was then calculated as $38.10. - The student calculated the expected return as 10.19% and standard deviation as 7.31% for an investment based on states of the economy, probabilities and rates of return for each state.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    258 views12 pages

    Muqaddas Zulfiqar 30101assignment 7

    Uploaded by

    Muqaddas Zulfiqar
    - The student calculated the expected return and standard deviation for a stock based on possible returns and probabilities of occurrence. The expected return was 20% and the standard deviation was 16.43%. - Using the CAPM model, the student calculated the required rate of return for a stock as 15.25% based on the stock's beta, risk-free rate, and expected market return. The present stock price was then calculated as $38.10. - The student calculated the expected return as 10.19% and standard deviation as 7.31% for an investment based on states of the economy, probabilities and rates of return for each state.

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    You are on page 1of 12

    FEDERAL URDU UNIVERSITY OF ART’S SCINCES AND

    TECHNOLOGY OF ISLAMABAD

    Student name: Muqaddas Zulfiqar


    Father name: Zulfiqar Ali
    MIS ID: 30101
    Subject: Introduction To Business Finance
    Submitted To: Miss Mehwish Aziz Khan

    Assignment # 7

    Question 1
    Suppose that your estimates of the possible one-year returns from investing in
    the common stock of the A. A. Eye-Eye Corporation were as follows:

    Probability of occurrence 0.1 0.2 0.4 0.2 0.1


    Possible return −10% 5% 20% 35% 50%

    What are the expected return and standard deviation?


    Answer
    STEP 1
    Calculation of expected return:
    Calculation of expected return= possible return × probability of occurance
    Calculation of expected return=[0.1 × 10%]+[0.2 × 5%]+[0.4 × 20%]+[0.2 ×
    35%]+[0.1 × 50%]
    Calculation of expected return= 20%
    STEP 2
    Calculation of standard deviation:
    Return Deviation dx^2 Probability (p) Pdx^2
    from mean
    (X-mean)dx
    -10% -30 900 0.1 90
    5% -15 225 0.2 45
    20% 0 0 0.4 0
    35% 15 225 0.2 45
    50% 30 900 0.1 90
    100 €Pdx^2= 270

    Mean= €X/n
    Mean= 100/5
    Mean= 20

    Standard deviation (SD)= √(€pdx^2)


    Standard deviation (SD)=√270
    Standard deviation (SD)=16.43
    Question 2
    Sorbond Industries has a beta of 1.45. The risk-free rate is 8 percent and the
    expected return on the market portfolio is 13 percent. The company currently
    pays a dividend of $2 a share, and investors expect it to experience a growth in
    dividends of 10 percent per annum for many years to come.
    a. What is the stock’s required rate of return according to the CAPM?
    b. What is the stock’s present market price per share, assuming this required
    return?

    Answer

    STEP 1
    Following information are provided in the question:
    Beta of Sorbond = 1.45
    Risk free rate = 8%
    Expected return on the market = 13%
    Dividend per share = $2
    Growth in dividend = 10% per annum
    STEP 2
    a. Required rate of return according to CAPM:
    CAPM or (Capital Asset Pricing Model) = Risk Free Rate + (Beta * (Expected
    market return - Risk Free Rate))
    CAPM or (Capital Asset Pricing Model) = 8% + (1.45*(13%-8%))
    CAPM or (Capital Asset Pricing Model) = 8%+7.25%
    CAPM or (Capital Asset Pricing Model) = 15.25%
    Required rate of return according to CAPM = 15.25%
    STEP 3
    b. Present market price per share:
    Under dividend discount model, P = D / (r - g)
    Where P = price of the share;
    D = Dividend per share = $2
    r = required rate of return = 15.25%
    g = growth rate = 10%
    Price of the share = $2/(15.25%-10%)
    Price of the share= $38.10
    Present market price per share = $38.10

    STEP 4
    c. Required return and market price if Beta were 0.80
    Required return using CAPM = Risk Free Rate + (Beta * (Expected market return -
    Risk Free Rate))
    Required return using CAPM = 8% + (0.80*(13%-8%))
    Required return using CAPM = 8%+4%
    Required return using CAPM = 12%
    Thus, required rate becomes 12% if the beta were 0.80

    STEP 5
    Price of the share = Under dividend discount model, P = D / (r - g)
    Price of the share = $2/(12%-10%)
    Price of the share = $2/2%
    Price of the share = $100
    Present market price per share if beta is 0.80 = $100
    Question 3
    Calculating Returns and Standard Deviations Based on the following
    information, calculate the expected return and standard deviation:

    Answer

    STEP 1
    The given data is sumarized as;
    State of economy Probability of state of Rate of return if state
    economy occurs
    Depression 0.10 -0.045
    Recession 0.25 0.044
    Normal 0.45 0.120
    Boom 0.20 0.207

    STEP 2
    Calculation of Expected return:
    Expected return = XR₁ + X₂ R₁ +X¸Ñ +X₂ R₁
    Expected return= 0.10(-0.045)+0.25(0.044) +0.45(0.120) +0.20(0.207)
    Expected return= 0.1019
    Expected return = 10.19%

    STEP 3
    Calculation of Standard Deviation:
    To calculate standard deviation the variance has to be found out. To calculate
    Variance Squared deviation for expected return is to be determined.
    Formula
    SD= SD(portfolio) = √Var(portfolio)
    Standard.deviation=0.10(-0.045-0.1019)²+0.25(0.044-0.1019)²
    +0.45(0.120−0.1019)² +0.20(0.207-0.1019)
    SD=0.00535
    SD = √0.00535
    SD = 0.0731
    Standard Deviation = 7.31%

    Question 4
    Calculating Returns and Standard Deviations Based on the following
    information, calculate the expected return and standard deviation for the two
    stocks:
    Answer

    STEP 1
    Calculating Returns and Standard Deviations - [LO1] :
    State of Prob Retu Px P(x- Return Py P(y-yi)^2
    Eco (p) rn xi)^2 on
    from B(y)%
    A(x)
    %
    Recess 0.15 6 0.9 0.41 -20 -3 421.153
    Normal 0.65 7 4.55 0.275 13 8.45 0.59
    Boom 0.20 11 2.2 2.245 33 6.6 87.78
    €px= 2.93 €py=1 509.524
    7.65 2.05
    Question 5
    Using CAPM A stock has a beta of 1.25, the expected return on the market is
    12 percent, and the risk-free rate is 5 percent. What must the expected return
    on this stock be?

    Answer

    STEP 1
    The given data is summarized as:
    Beta of stock = 1.25
    Expected Return = 12%
    Risk-free rate = 5%

    STEP 2
    Formula of CAPM is:
    E(Ri)=Rf,+Bi, (Rm-Ri)
    Where E (Ri) = Expected return on the stock
    Rf= Risk Free Rate
    Bi= Stock's Beta
    E (RM) = Expected return on the market portfolio
    E(Ri) = 0.05+1.25(0.12 -0.05)
    E(Ri) = 0.05 +1.25(0.07)
    E(Ri) = 0.1375
    Expected Return on stock = 13.75%
    Question 6
    Using CAPM A stock has an expected return of 14.2 percent, the risk-free rate
    is 4 percent, and the market risk premium is 7 percent. What must the beta of
    this stock be?

    Answer:

    STEP 1
    The given data is summarized as.
    Expected rate of return of the stock = 14.2%
    Risk-free rate = 6%
    Market risk premium = 7%

    STEP 2
    Calculation of beta of stock:
    Market risk premium is the Expected return of the market minus the Risk-free rate.
    Formula of CAPM
    E(Ri)=Rf+Bi (RM-Rf)
    Where E (Ri) = Expected return on the stock
    RF = Risk Free Rate
    B = Stock's Beta
    E (RM) = Expected return on the market portfolio
    0.142 0.04 +B(0.07)
    B = 1.46
    Beta of the stock = 1.46
    Question 7
    Using CAPM A stock has an expected return of 10.5 percent, its beta is .73,
    and the risk-free rate is 5.5 percent. What must the expected return on the
    market be?

    Answer

    STEP 1
    The given data is summarized as:
    Expected return of the stock = 10.5%
    Risk-free return = 5.5%
    Beta of the stock = 0.73

    STEP 2
    Calculation of the Expected return of the market
    Formula of CAPM:
    E(Ri) = RF+Bi (RM-RE)
    Where E (Ri) = Expected return on the stock
    RF = Risk Free Rate
    B= Stock's Beta
    E (RM) = Expected return on the market portfolio
    0.105= 0.055 +0.73(RM -0.055)
    RM= 0.09015+ 0.73
    RM = 0.12349
    Expected return on the market = 12.35%

    Question 8
    Using CAPM A stock has an expected return of 16.2 percent, a beta of 1.75,
    and the expected return on the market is 11 percent. What must the risk-free
    rate be?

    Answer

    STEP 1:
    The given data is summarized as
    Expected return of the stock = 16.2%
    Beta of the stock = 1.75
    Expected return of the market = 11%

    STEP 2:
    Calculation of Risk free rate:
    Formula of CAPM:

    E(Ri)= Rf+Bi(E(RM)-Rf)
    Where E (R₁ ) = Expected return on the stock
    RF= Risk Free Rate
    B = Stock's Beta
    E (RM)= Expected return on the market portfolio
    0.162= Rf +1.75(0.11-Rf)
    0.162 = Rf +0.1925-1.75Rf
    RF = 0.04066
    Risk-free rate = 4.07%

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