EXAM 2 TOPIC 8 Flashcards Preview

FINA > EXAM 2 TOPIC 8 > Flashcards

Flashcards in EXAM 2 TOPIC 8 Deck (24)
Loading flashcards...
1

standard deviation

2

Standard deviation

3

HOLDING PERIOD RETURN a)

4

BREAKDOWN Holding Period Return FORMULA INTO FORMULAS FOR DIVIDEND YIELD AND CAPITAL GAINS YIELD

5

DIVIDEND YIELD FORMULA b)

6

CAPITAL GAINS FORMULA c)

7

FISHER EFFECT EX ANTE AND EX POST FORMULAS

8

FISHER EFFECT IS USED TO FIND ___?

REAL RISK FREE RATE OF INTEREST

9

REAL RATE OF INTEREST FORMULA

10

standard deviation

11

standard deviation

12

expected return of the portfolio

Further, suppose that 40% of the portfolio is invested in Stock X and 60% in Stock Y. In order to calculate the standard deviation of the portfolio, first we need to calculate the expected returns of both stocks:

E[Rx]=.21×(−2%)+.46×11%+.33×26%=13.22%E[Rx]=.21×(−2%)+.46×11%+.33×26%=13.22%

E[Ry]=.21×3%+.46×13%+.33×14%=11.23%E[Ry]=.21×3%+.46×13%+.33×14%=11.23%

The expected return on a portfolio is simply the weighted average of the returns on the individual assets. As such, the expected return on our example portfolio is:

E[Rp]=.4×13.22%+.6×11.23%=12%E[Rp]=.4×13.22%+.6×11.23%=12%

Next, calculate the standard deviations of each stock:

σx=√.21(−2%−13.22%)2+.46(11%−13.22%)2+.33(26%−13.22%)2=10.24%σx=.21(−2%−13.22%)2+.46(11%−13.22%)2+.33(26%−13.22%)2=10.24%

σy=√.21(3%−11.23%)2+.46(13%−11.23%)2+.33(14%−11.23%)2=4.27%σy=.21(3%−11.23%)2+.46(13%−11.23%)2+.33(14%−11.23%)2=4.27%

The covariance of the two stocks are:

COVx,y=.21×(−2%−13.22%)×(3%−11.23%)+.46×(11%−13.22%)×(13%−11.23%)+.33×(26%−13.22%)×(14%−11.23%)=36.18%COVx,y=.21×(−2%−13.22%)×(3%−11.23%)+.46×(11%−13.22%)×(13%−11.23%)+.33×(26%−13.22%)×(14%−11.23%)=36.18%

Given the standard deviation of each individual asset and the covariance of the two assets, the correlation coefficient of these stocks is:

ϱa,b=36.18%10.24%×4.27%=.82ϱa,b=36.18%10.24%×4.27%=.82

Therefore, the standard deviation of the portfolio is (using the correlation coefficient):

σp=√(.4)2×(10.24%)2+(.6)2×(4.27%)2+2×.4×.6×.8256×10.24%×4.27%=6.38%

13

beta definition

measures how correlated the firm's returns are with the returns of the entire market's returns

14

KAPM EQUATION

15

RISK FREE RATE =

16

BUILD UP METHOD FORMULA

17

VMX is a newer company that produces cooling products for CPUs.  The company has an estimated beta of 2.1.  If you expect market returns to be 12% and the risk free rate to be 3%, then what are your expected returns for VMX using the CAPM?

18

A company that you are analyzing has a beta of 1.  The expected market return is 14.5%.  According to the CAPM, what is the expected return of this company?

19

GKL and Associates has a beta of 1.1.  The market risk premium is expected to be 8% and the risk free rate is 3.5%.  According to the CAPM, what is the expected return for GKL?

20

Suppose a company has a beta of .86.  Also, assume the market risk premium is 10% and the expected return on the market is 13.5%.  According to the CAPM, what is the expected return for this company?

21

(Required rate of return using CAPM) Compute Bowling Avenue Inc.’s required rate of return given a beta of .9, risk free rate of 3.25%, and the average market return of 9%.

22

(Capital asset pricing model) Compute Fine Co.’s required rate of return given a beta of 1.5, risk free rate of 5%, and a market premium of 4%.

23

24