Chapter 2: Question 9B (page 259)
“Highly variable stock prices suggest that the market does not know how to price stocks.” Respond.
The correct answer is ‘Incorrect statement’.
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Use the following scenario analysis for stocks X and Y to answer CFA Questions
Question: Assume that of your \(10,000 portfolio, you invest \)9,000 in stock X and $1,000 in stock Y. What is the expected return on your portfolio?
What do you think would happen to the expected return on stocks if investors perceived an increase in the volatility of stocks?
If the simple CAPM is valid, which of the situations in Problems 13 – 19 below are possible? Explain. Consider each situation independently.
Portfolio | Expected Return | Standard Deviation |
A B | 30% 40 | 35% 25 |
Based on current dividend yields and expected capital gains, the expected rates of return on portfolios A and B are 11% and 14%, respectively. The beta of A is .8 while that of B is 1.5. The T-bill rate is currently 6%, while the expected rate of return of the S&P 500 Index is 12%. The standard deviation of portfolio A is 10% annually, while that of B is 31%, and that of the index is 20%.
a. If you currently hold a market-index portfolio, would you choose to add either of these portfolios to your holdings? Explain.
b. If instead you could invest only in bills and one of these portfolios, which would you choose?
The market price of a security is $40. Its expected rate of return is 13%. The risk-free rate is 7%, and the market risk premium is 8%. What will the market price of the security be if its beta doubles (and all other variables remain unchanged)? Assume the stock is expected to pay a constant dividend in perpetuity.
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