24 May Question [i]. Assume a new law is passed that restricts investors to h
Question
[i]. Assume a new law is passed that restricts investors to holding only one asset. A risk-averse investor is considering two possible assets as the asset to be held in isolation. The assets’ possible returns and related probabilities (that is, the probability distributions) are as follows:
Asset X Asset Y
P k P k
0.10 -3% 0.05 -3%
0.10 2 0.10 2
0.25 5 0.30 5
0.25 8 0.30 8
0.30 10 0.25 10
Which asset should be preferred?
a. Asset X, since its expected return is higher.
b. Asset Y, since its beta is probably lower.
c. Either one, since the expected returns are the same.
d. Asset X, since its standard deviation is lower.
e. Asset Y, since its coefficient of variation is lower and its expected return is higher.
[ii]. Given the following probability distribution, what are the expected return and the standard deviation of returns for Security J?
State PikJ
1 0.2 10%
2 0.6 15
3 0.2 20
a. 15%; 6.50%
b. 12%; 5.18%
c. 15%; 3.16%
d. 15%; 10.00%
e. 20%; 5.00%
[iii]. You are holding a stock that has a beta of 2.0 and is currently in equilibrium. The required return on the stock is 15 percent, and the return on an average stock is 10 percent. What would be the percentage change in the return on the stock, if the return on an average stock increased by 30 percent while the risk-free rate remained unchanged?
a. +20%
b. +30%
c. +40%
d. +50%
e. +60%
[iv]. Oakdale Furniture Inc. has a beta coefficient of 0.7 and a required rate of return of 15 percent. The market risk premium is currently 5 percent. If the inflation premium increases by 2 percentage points, and Oakdale acquires new assets that increase its beta by 50 percent, what will be Oakdale’s new required rate of return?
a. 13.50%
b. 22.80%
c. 18.75%
d. 15.25%
e. 17.00%
[v]. Partridge P
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