FIN 419 HOMEWORK 3 (CAPM)

FIN 419 HOMEWORK 3 (CAPM)

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HOMEWORK #3 (CAPM)

FIN 419

1. Mark has $5 million invested in long-term corporate bonds. The expected annual rate of return of his bond portfolio is 9%, and its annual standard deviation is 10%. His adviser recommends that Mark consider investing in an index stock fund that tracks the S&P 500 Index, has an expected return of 14%, and its standard deviation is 16%.

a. Assume Mark puts all his money in a combination of the index fund and Treasury bills. Can he thereby improve his expected rate of return without changing the risk of his portfolio? The Treasury bill yield is 6%.

b. Could Mark do even better by investing equal amounts in the corporate bond portfolio and the index fund? The correlation between the bond portfolio and the index fund is + 0.1.

2. The market price of a stock is $40, the stock's required rate of return is 13%, the riskless rate of interest is 7%, and the market risk premium is 8%.

a. What is the stock's beta?

b. If you expect to sell the stock for $50 in one year from now, is the stock properly priced currently? Assume the stock is not expected to make any payments over the year.