Corporate finance, CAPM, beta equation, practice exam problems


Corporate finance, CAPM, beta equation, practice exam problems

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NEAS
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Corporate finance, CAPM, beta equation, practice exam problems

(The attached PDF file has better formatting.)

*Question 1.1: Expected Return

A stock with a CAPM β of 0.800 has an expected return of 12%, and a stock with a CAPM β of 1.200 has an expected return of 14%. What is the expected return for a stock with a CAPM β of 1.500?

15.0%

15.5%

16.0%

16.5%

17.0%

Answer 1.1: B

We use the CAPM equation and a pair of simultaneous linear equations to find the risk-free rate and the market risk premium.

12% = risk-free rate + 0.800 × market risk premium

14% = risk-free rate + 1.200 × market risk premium

A (1.200 – 0.800) × market risk premium = 14% – 12% = 2%

A market risk premium = 2% / 0.4 = 5%

To find the risk-free rate: 12% = risk-free rate + 0.8 × 5% A risk-free rate = 8%

The expected return on this stock is 8% + 1.5 × 5% = 15.5%

*Question 1.2: Betas

The CAPM beta of stock W is 1.200, the CAPM beta of stock Y is 0.800, and the risk-free rate equals the market risk premium. How much greater is the expected return on Stock W than the expected return on Stock Y?

The same

20% greater

22% greater

40% greater

50% greater

Answer 1.2: C

Let the risk-free rate be R, so the market risk premium is also R.

The expected return on Stock W is R + 1.2 × R = 2.2 × R.

The expected return on Stock Y is R + 0.8 × R = 1.8 × R.

The ratio of the expected returns is 2.2R / 1.8R = 1.222


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NEAS - 7/6/2006 1:52:20 PM

Corporate finance, CAPM, beta equation, practice exam problems

(The attached PDF file has better formatting.)

*Question 1.1: Expected Return

A stock with a CAPM β of 0.800 has an expected return of 12%, and a stock with a CAPM β of 1.200 has an expected return of 14%. What is the expected return for a stock with a CAPM β of 1.500?

15.0%

15.5%

16.0%

16.5%

17.0%

Answer 1.1: B

We use the CAPM equation and a pair of simultaneous linear equations to find the risk-free rate and the market risk premium.

12% = risk-free rate + 0.800 × market risk premium

14% = risk-free rate + 1.200 × market risk premium

A (1.200 – 0.800) × market risk premium = 14% – 12% = 2%

A market risk premium = 2% / 0.4 = 5%

To find the risk-free rate: 12% = risk-free rate + 0.8 × 5% A risk-free rate = 8%

The expected return on this stock is 8% + 1.5 × 5% = 15.5%

*Question 1.2: Betas

The CAPM beta of stock W is 1.200, the CAPM beta of stock Y is 0.800, and the risk-free rate equals the market risk premium. How much greater is the expected return on Stock W than the expected return on Stock Y?

The same

20% greater

22% greater

40% greater

50% greater

Answer 1.2: C

Let the risk-free rate be R, so the market risk premium is also R.

The expected return on Stock W is R + 1.2 × R = 2.2 × R.

The expected return on Stock Y is R + 0.8 × R = 1.8 × R.

The ratio of the expected returns is 2.2R / 1.8R = 1.222


 

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