Question

You have been provided the following data about the securities of three firms, the market portfolio, and the risk-free asset:

  

a.	Fill in the missing values in the table. (Leave no cells blank - be certain to enter 0 wherever required. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

  

Security	Expected Return	Standard Deviation	Correlation*	Beta
Firm A	0.104	0.35		0.81
Firm B	0.144		0.54	1.36
Firm C	0.164	0.61	0.39
The market portfolio	0.12	0.21
The risk-free asset	0.05

* With the market portfolio

   

b-1.	What is the expected return of Firm A? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Expected return%

What is the expected return of Firm B? Firm C?

Answer 1

1. Correlation of Firm A = Beta * Market SD / Firm A SD

Correlation of Firm A = 0.81 * 0.21 / 0.35

Correlation of Firm A = 0.49

2. SD of Firm B = Beta * Market SD / Correlation

SD of Firm B = 1.36 * 0.21 / 0.54

SD of Firm B = 0.53

3. Firm C Beta = SD of Firm C * Correlation / market SD

Firm C Beta = 0.61 * 0.39 / 0.21

Firm C Beta = 1.13

4. Market Portfolio Correlation = 1

5. Market Portfolio Beta = 1

6. Expected Return

Firm A = Risk Free + Beta * (Market rate- Risk Rate)

Firm A = 0.05 + 0.81 * (0.12- 0.05)

Firm A = 10.67%

Firm B = Risk Free + Beta * (Market rate- Risk Rate)

Firm B = 0.05 + 1.36 * (0.12- 0.05)

Firm B = 14.52%

Firm C = Risk Free + Beta * (Market rate- Risk Rate)

Firm C = 0.05 + 1.13 * (0.12- 0.05)

Firm C = 12.91%