Consider the following table, which gives a security analyst\'s expected return
ID: 2744951 • Letter: C
Question
Consider the following table, which gives a security analyst's expected return on two stocks for two particular market returns: What are the betas of the two stocks? (Do not round intermediate calculations. Round your answers to 2 decimal places.) What is the expected rate of return on each stock if the market return is equally likely to be 4% or 24%? (Do not round intermediate calculations. Round your answers to 1 decimal place. Omit the "%" sign in your response.) What hurdle rate should be used by the management of the aggressive firm for a project with the risk characteristics of the defensive firm's stock if market return is equally likely to be 4% or 24%? Also, assume a T-Bill rate of 3%. (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "%" sign in your response.)Explanation / Answer
a. Betas
Aggressive Stock - (Excel Formula) = slope(-2%:34%,4%:24%) = 1.8
Defensive Stock = slope(3%:12%,4%:24%) = 0.45
b. Expected Return is the weighted average probability of two scenarios
Aggressive Stock = 0.5x(-2%) + 0.5x(34%) = 16.00%
Defensive Stock = 0.5x(3%) + 0.5x(12%) = 7.50%
c. Use CAPM, we know that E(R) = Rf + Beta x (Rm - Rf)
we know that Rm = 0.5 x (4% + 24%) = 14%, Rf = 3%, Beta (Defensive) = 0.45
Hurdle Rate = 3% + 0.45 x (14% - 3%) = 7.95%