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and M. Stock L will represent 40% of the dollar value of the portfolio,
and stock M will account for the other 60%. The expected returns
over the next 6 years, 2015–2020, for each of these stocks are shown
in the following table. Expected return Year Stock L Stock M 2015
14% 20% 2016 14 18 2017 16 16 2018 17 14 2019 17 12 2020 19 10
a. Calculate the expected portfolio return, rp, for each of the 6 years.
b. Calculate the expected value of portfolio returns, , over the 6-year
period. c. Calculate the standard deviation of expected portfolio
returns, , over the 6-year period. d. How would you characterize the
correlation of returns of the two stocks L and M? e. Discuss any
benefits of diversification achieved by Jamie through creation of the
portfolio. P8–24 Capital asset pricing model (CAPM) For each of the
cases shown in the following table, use the capital asset pricing model
to find the required return. Case Risk-free rate, RF Market return, rm
Beta,β A 5% 8% 1.30 B 8 13 0.90 C 9 12 −0.20 D 10 15 1.00 E 6 10
0.60 P8–25 Beta coefficients and the capital asset pricing model
Katherine Wilson is wondering how much risk she must undertake to
generate an acceptable return on her portfolio. The risk-free return
currently is 5%. The return on the overall stock market is 16%. Use
the CAPM to calculate how high the beta coefficient of Katherine’s
portfolio would have to be to achieve each of the following expected
portfolio returns. a. 10% b. 15% c. 18% d. 20% e. Katherine is risk
averse. What is the highest return she can expect if she is unwilling to
take more than an average risk? P8–26 Manipulating CAPM Use the
basic equation for the capital asset pricing model (CAPM) to work
each of the following problems. a. Find the required return for an
asset with a beta of 0.90 when the risk-free rate and market return are
8% and 12%, respectively. b. Find the risk-free rate for a firm with a
required return of 15% and a beta of 1.25 when the market return is
14%. c. Find the market return for an asset with a required return of
16% and a beta of 1.10 when the risk-free rate is 9%. d. Find the beta
for an asset with a required return of 15% when the risk-free rate and
market return are 10% and 12.5%, respectively. P5–1 Using a time
line The financial manager at Starbuck Industries is considering an
investment that requires an initial outlay of $25,000 and is expected to
result in cash inflows of $3,000 at the end of year 1, $6,000 at the end
of years 2 and 3, $10,000 at the end of year 4, $8,000 at the end of