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Homework answers / question archive /  1) Dallas Star Inc

 1) Dallas Star Inc

Finance

 1) Dallas Star Inc. 's stock has a 35% chance of producing a 10% return, and a 60% chance of producing a 15% return. What is the firm's expected rate of return? What is the firm's Standard Deviation? What is the firm's Coefficient of Variation?

2) Malcom Jones has 40% invested in Stock A with the rest invested in Stock B. The variance of Stock A is 2% and the standard deviation of Stock B is 11%. The correlation between Stock A and Stock B is 0.690. Calculate the standard deviation of the portfolio. (3 marks) Please provide your answer as a decimal to 4 decimal places.

3)  Calculate the required rate of return for Dallas Star Inc., assuming that (1) the nominal risk-free rate is 4.0%, (2) expected market return is 10% and (3) the firm has a beta of 1.2. (Hint: You need to find out market risk premium first.)

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1) Expected rate of return = 13%

Standard deviation = 2.45%

Coefficient of variation = 0.19

2) Computation of the standard deviation of portfolio:-

Standard deviation of stock B = Variance^(1/2)

= 2%^(1/2)

= 14.14%

Standard deviation of portfolio = (((WA^2)*(Stdev.A^2))+((WB^2)*(Stdev.B^2))+(2*WA*WB*Stdev.A*Stdev.B*Correlation))^(1/2)

= (((40%^2)*(14.14%^2))+((60%^2)*(11%^2))+(2*40%*60%*14.14%*11%*0.690))^(1/2)

= (0.3200%+0.4356%+0.5151%)^(1/2)

= 1.2707%^(1/2)

= 11.2727%

3) Computation of the required rate of return:-

market risk premium = Expected market return - Risk free rate

= 10% - 4%

= 6%

Required rate of return = Risk free rate + (Beta * Market risk premium)

= 4% + (1.2 * 6%)

= 4% + 7.20%

= 11.20%

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