6-13 You have observed the following returns over time:
Year Stock X Stock Y Market
2003 14% 13% 12%
2004 19% 7% 10%
2005 216% 25% 212%
2006 3% 1% 1%
2007 20% 11% 15%
Assume that the risk-free rate is 6% and the market risk premium is 5%.
a. What are the betas of Stocks X and Y?
b. What are the required rates of return for Stocks X and Y?
c. What is the required rate of return for a portfolio consisting of 80% of Stock X and 20% of Stock Y?
d. If Stock X’s expected return is 22%, is Stock X under- or over-valued?
Year Stock X Stock Y Market
2003 14% 13% 12%
2004 19% 7% 10%
2005 216% 25% 212%
2006 3% 1% 1%
2007 20% 11% 15%
Assume that the risk-free rate is 6% and the market risk premium is 5%.
a. What are the betas of Stocks X and Y?
b. What are the required rates of return for Stocks X and Y?
c. What is the required rate of return for a portfolio consisting of 80% of Stock X and 20% of Stock Y?
d. If Stock X’s expected return is 22%, is Stock X under- or over-valued?
SOLUTION PREVIEW
b. What
are the required rates of return for Stocks X and Y?
k X = 6% + (5%)1.3471 = 12.7355%.
k
Y = 6% + (5%)0.6516 = 9.2540%.
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