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Chapter 2: Q10C. (page 145)

Probabilities for three states of the economy and probabilities for the returns on a particular stock in each state are shown in the table below:

Question: What is the probability that the economy will be neutral and the stock will experience poor performance?

Short Answer

Expert verified

The correct answer is: 0.50 for neutral economy and 0.15 for poor stock performance

Step by step solution

01

Given information

Probability of economy being good = 0.3

Probability of economy being neutral = 0.5

Probability of economy being poor = 0.2

Probability of poor performance of stock in neutral economy = 0.3

02

Explanation

Hence, the probability of a neutral economy and poor stock performance = Probability of economy being neutral x Probability of poor Performance of stock in neutral economy

= 0.5 x 0.3

= 0.15

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Most popular questions from this chapter

Assume that both X and Y are well-diversified portfolios and the risk-free rate is 8%.

Portfolio

Expected Return

Beta

X

Y

16%

12%

1.00

0.25

In this situation you could conclude that portfolios X and Y:

a. Are in equilibrium.

b. Offer an arbitrage opportunity.

c. Are both under priced.

d. Are both fairly priced.

Which of the following observations would provide evidence against the semi-strong form of the efficient market theory? Explain.

a. Mutual fund managers do not on average make superior returns.

b. You cannot make superior profits by buying (or selling) stocks after the announcement of an abnormal rise in dividends.

c. Low P/E stocks tend to have positive abnormal returns.

d. In any year approximately 50% of pension funds outperform the market.

Consider the following table, which gives a security analyst’s expected return on two stocks for two particular market returns:

a. What are the betas of the two stocks?

b. What is the expected rate of return on each stock if the market return is equally likely to be 5% or 20%?

c. If the T-bill rate is 8%, and the market return is equally likely to be 5% or 20%, draw the SML for this economy.

d. Plot the two securities on the SML graph. What are the alphas of each?

e. What hurdle rate should be used by the management of the aggressive firm for a project with the risk characteristics of the defensive firm’s stock?

What must be the beta of a portfolio with E (r P ) = 20%, if rf = 5% and E ( r M ) = 15%?

What is the reward-to-volatility ratio for the equity fund in the previous problem?
See all solutions

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