Sample Problems—Risk and rates of return

1. An investor is forming a portfolio by investing $50,000 in stock A which has a beta of 1.50, and
$25,000 in stock B which has a beta of 0.90. The return on the market is equal to 6 percent and
Treasury bonds have a yield of 4 percent. What is the required rate of return on the investor’s
portfolio?

2. Given the following probability distribution, what is the expected return and the standard deviation of
returns for Security J?

State Pi Rj
1 0.2 10%
2 0.6 15%
3 0.2 20%

3. You hold four stocks in your portfolio—Stock A, Stock B, Stock C, and Stock D. Your portfolio beta
is 1.2. Stock C constitutes 40 percent of the dollar value of your holdings and has a beta of 0.60. If
you sell all of your holdings in Stock C, and replace them with an equal investment in Stock E (which
has a beta of 0.95), your new portfolio beta will be ________.

4. If Rf = 7%, RM = 12%, and Rj = 15%, what is the stock's beta?

5. You are given the following distribution of dollar returns:

Probability Return
40% $30
50% $25
10% -$25

What is the standard deviation of the expected dollar returns?

6. If the risk-free rate is 7 percent, the expected return on the market is 10 percent, and the expected
return on Security J is 13 percent, what is the beta of Security J?

7. You hold a diversified portfolio consisting of a $10,000 investment in each of 20 different common
stocks (i.e., our total investment is $200,000). The portfolio beta is equal to 1.2. You have decided to
sell one of your stocks, which has a beta equal to 0.7 for $10,000. You plan to use the proceeds to
purchase another stock which has a beta equal to 1.4. What will be the beta of the new portfolio?

8. Given the following probability distribution, what are the expected return and the standard deviation of
returns for Security J?
State Pi Rj
1 0.2 10%
2 0.6 15%
3 0.2 20%

9. The table below gives the portfolio weights and the beta coefficients of three stocks that you will hold
as your portfolio. If the risk free rate is 6% per year, and the return on the market portfolio is 18% per
year, what the expected return on this portfolio?.
Stock Portfolio Weight Beta
A 0.50 1.8
B 0.20 0.40
C 0.30 1.20
10. The price of stock J is $40 per share, and that of stock K is $60 per share. Suppose you form a
portfolio of these two stocks by buying 100 shares of stock J and 400 shares of stock K. In this
portfolio, what would be the weight of stock K?

11. The table below gives the portfolio weights and the beta coefficients of three stocks that you will hold
as your portfolio. If the risk free rate is 6% per year, and the return on the market portfolio is 18% per
year, what is the expected return on this portfolio?

Stock Portfolio weight Beta coefficient

J 0.50 0.80
K 0.20 1.40
L 0.30 1.20

12. An analyst has provided information on possible returns for ABC Corporation stock. What is the
standard deviation of expected returns for this stock, given the following distribution?

Pri Ri
Scenario 1 20% -40%
Scenario 2 50% 0%
Scenario 3 30% 30%

13. You hold three stocks in your portfolio--stock A, stock B, and stock C. The portfolio beta is 1.50.
Stock A makes up 20 percent of the dollar value of your holdings and has a beta of 1.00. If you sell all
of your holdings in stock A, and replace them with an equal investment in stock D (which has a beta of
1.25), what will be the beta of your new portfolio?

14. You form a portfolio with 45% invested in stock X and the remainder in stock Y. The expected return
for stock X is 14% and the expected return for stock Y is 22%. What is the expected return of the
portfolio?

15. Asset A has an expected return of 15% and a beta of 0.95. The risk-free rate is 5 percent. What is the
market risk premium?

16. Which of the following stocks

Probability Return for

(Pri) Stock A Stock B
Boom 30% 60% 50%
Good 40% 30% 30%
Recession 30% 5% -5%

has the greatest expected return and by how much?

17. You are given the following probability distribution of returns:

Probability Return
40% $30
50% $25
10% -$20

What is the coefficient of variation of the expected dollar returns?

18. You hold a diversified portfolio consisting of a $20,000 investment in each of 10 different common
stocks (i.e., our total investment is $200,000). The portfolio beta is equal to 1.2. You have decided to
sell one of your stocks, which has a beta equal to 0.7 for $20,000. You plan to use the proceeds to
purchase another stock that has a beta equal to 1.4. What will be the beta of the new portfolio?
19. Given the following probability distribution, what are the expected return and the standard deviation of
returns for Security J?
State Pi Rj
1 0.2 10%
2 0.6 15%
3 0.2 20%

20. The table below gives the portfolio weights and the beta coefficients of three stocks that you will hold
as your portfolio. If the risk free rate is 5% per year, and the return on the market portfolio is 12% per
year, what the expected return on this portfolio?.
Stock Portfolio Weight Beta
A 0.50 1.20
B 0.20 0.40
C 0.30 1.80

21. If the risk-free rate is 4 percent, the expected return on the market is 6 percent, and the expected return
on Metallica Bearings, Inc. is 8 percent, what is beta of Metallica?

22. You have a total of $30,000 invested in three stocks:

Stock Investment Stock’s Beta

Coefficient
A $6,000 1.0
B $15,000 1.25
C $9,000 1.75

What is the beta of you portfolio?

23. The expected return for a portfolio that is 70% invested in A and 30% invested in B is 19.18%. What
is the standard deviation of returns for this portfolio?

Probability Return on A Return on B

Boom 0.65 30% 5%
Bust 0.35 10% 20%
E(R) 23% 10.25%
σ 9.54% 7.15%

24. A stock was priced at $121.18 at the beginning of the year and $126.72 at the end of the year. The
company also paid a dividend of $3.08 per share.
What is the dividend yield, capital gains yield, and total percentage return for the investment?

25. Large-company stocks earned the following returns for the years 1998 through 2001:

Year Return
1998 28.6%
1999 21.0%
2000 -9.1%
2001 -11.9%

What is the average return and standard deviation of returns for large-company stocks?

26. A money manager is holding the following portfolio:

 Stock Portfolio weight (Xi) Beta
1 20% 0.6
2 20% 1.0
3 30% 1.4
4 30% 1.8

The risk-free rate is 6 percent and the market risk premium is 4.75 percent. Calculate the portfolio's
required rate of return.

27.
State Probability Return on A Return on B
Boom 30% 12% -2%
Normal 60% 8% 2%
Bust 10% 4% 6%

Suppose you have $20,000 total. If you put $6,000 in Stock A and the remainder in Stock B, what will be
the standard deviation of your portfolio? (The expected return for the portfolio is 3.48%)

28. Asset A has an expected return of 14.5% and a beta of 1.15. The risk-free rate is 5%. What is the
market risk premium?

29. What is the Beta for the following portfolio?

Stock A B C D E
Investment ($) $25,000 $10,000 $15,000 $40,000 $35,000
Beta 0.75 0.95 1.25 1.50 0.00

30. What is the standard deviation of a portfolio with one-quarter of the funds in A and the remainder
of the funds in B?

State Probability Return on A Return on B

Boom 0.65 0.30 0.05
Bust 0.35 0.10 0.20