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MAIN MENU -- CHAPTER 13

Problem 13-11 Problem 13-17 Problem 13-23

Problem 13-24 Problem 13-27

Fundamentals of Corporate Finance by Ross, Westerfield, and Jordan -- Fifth Edition

Copyright © 2000 Irwin/McGraw-Hill and KMT Software, Inc. (www.kmt.com)

File: 766207387.xls Copyright © 1997 Richard D. Irwin, Inc. Printed: 06/21/2024

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File: 766207387.xls Copyright © 1997 Richard D. Irwin, Inc. Printed: 06/21/2024

Fundamentals of Corporate Finance
Ross, Westerfield, and Jordan -- Fifth Edition

Problem 13-11 Objective

Calculate the beta of a portfolio.

Student Name:
Course Name:
Student ID:
Course Number:

You own a stock portfolio invested 30 percent in Stock Q, 20 percent in Stock R, 10 percent in Stock S,
and 40 percent in Stock T. The betas for these four stocks are 1.4, .6, 1.5, and 1.8, respectively. What is
the portfolio beta?

Solution
Instructions
Enter the data and formulas needed to calculate the beta of the portfolio.

Calculation of
Percent Stock Portfolio
Invested Beta Beta
Stock Q 30% FORMULA
Stock R 20% FORMULA
Stock S 10% FORMULA
Stock T 40% FORMULA
100% FORMULA <--- Beta of the portfolio

Problem: 13-11 Copyright © 1997 Richard D. Irwin, Inc. Printed: 06/21/2024

Fundamentals of Corporate Finance
Ross, Westerfield, and Jordan -- Fifth Edition

Problem 13-17 Objective

Calculating expected return using CAPM.

Student Name:
Course Name:
Student ID:
Course Number:

A stock has a beta of .8 and an expected return of 13 percent. A risk-free asset currently earns 4 percent.

a. What is the expected return on a portfolio that is equally invested in the two assets?
b. If a portfolio of the two assets has a beta of .6, what are the portfolio weights?
c. If a portfolio of the two assets has an expected return of 11 percent, what is its beta?

d. If a portfolio of the two assets has a beta of 1.8, what are the portfolio weights? How do you interpret the
weights for the two assets in this case? Explain.

Solution
Instructions
Enter data, cell references, and formulas to solve the problem.

Basic Data
Stock Beta 0.8
Stock expected return 13%
Risk-free rate 4%

a. What is the expected return on a portfolio that is equally invested in the two assets?

Expected return FORMULA

b. If a portfolio of the two assets has a beta of .6, what are the portfolio weights?

Investments Beta Weights Beta

Stock 0.8 100% 0.80
Risk free investment 0.00
0.80 <-- Portfolio beta

c. If a portfolio of the two assets has an expected return of 11 percent, what is its beta?

Investment Portfolio
Expected Expected
Investments Return Weights Return
Stock 100% FORMULA
Risk free investment FORMULA
0.0%
Portfolio beta 0.80

d. If a portfolio of the two assets has a beta of 1.6, what are the portfolio weights? How do you interpret the
weights for the two assets in this case? Explain.

Expected Expected
Investments Beta Weights Beta
Stock 13% 100% 13.0%
Risk free investment 4% 0.0%
13.0%
Portfolio beta 0.80

Problem: 13-17 Copyright © 1997 Richard D. Irwin, Inc. Printed: 06/21/2024

Fundamentals of Corporate Finance
Ross, Westerfield, and Jordan -- Fifth Edition

Problem 13-23 Objective

Calculate portfolio expected return, variance, and standard deviation.

Student Name:
Course Name:
Student ID:
Course Number:

Consider the following information on a portfolio of stocks:

Probability of
State of state of Rate of return if state occurs
Economy economy Stock A Stock B Stock C

Boom 30% 40% 35% 60%

Normal 50% 15% 15% 5%
Bust 20% 0% -25% -75%

a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio
expected return? The variance? The standard deviation?

b. If the expected T-Bill rate is 3.80 percent, what is the expected risk premium on the portfolio?

c. If the expected inflation rate is 3.50 percent, what are the approximate and exact expected real returns
on the portfolio? What are the approximate and exact real risk premiums on the portfolio?

a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio
expected return? The variance? The standard deviation?

Solution
Instructions
Use formulas and Excel functions to calculate expected return, variance, and standard deviation.

Stock Weights
A 40%
B 40%
C 20%

Probability of Weighted Expected

State of state of Rate of return if state occurs Portfolio Portfolio
Economy economy Stock A Stock B Stock C Return Return
Boom 30% FORMULA FORMULA FORMULA 0% FORMULA
Normal 50% FORMULA FORMULA FORMULA 0% FORMULA
Bust 20% FORMULA FORMULA FORMULA 0% FORMULA
Expected return 0.00%

Variance FORMULA
Standard Deviation FORMULA

b. If the expected T-Bill rate is 3.80 percent, what is the expected risk premium on the portfolio?

Expected return 0.00%

Risk free rate
Expected risk premium FORMULA

c. If the expected inflation rate is 3.50 percent, what are the approximate and exact expected real returns
on the portfolio? What are the approximate and exact real risk premiums on the portfolio?

Approximate Expected Real Return

Expected return 0.00%
Less: inflation rate
Approximate expected real return 0.00%

Exact expected real return 0.00%

Approximate expected real risk premium 0.00%
Exact expected real risk premium 0.00%

Problem: 13-23 Copyright © 1997 Richard D. Irwin, Inc. Printed: 06/21/2024

Fundamentals of Corporate Finance
Ross, Westerfield, and Jordan -- Fifth Edition

Problem 13-24 Objective

Allocate assets to create a portfolio with risk equal to that of the market.

Student Name:
Course Name:
Student ID:
Course Number:

You want to create a portfolio equally as risky as the market, and you have $500,000 to invest. Given this
information, fill in the rest of the following table:

Asset Investment Beta

Stock A $140,000 0.9

Stock B $140,000 1.2
Stock C 1.60
Risk-free asset

Solution
Instructions
Enter the investment amounts for Stock C and the risk-free asset that result in a beta equal to the market
(market = 1).
Calculation
Portfolio
Asset Investment Beta Weights Beta
Stock A $140,000 0.9 50% 0.5

Stock B 140,000 1.2 50% 0.6

Stock C 1.6 0% 0.0
Risk-free asset 0% 0.0
$280,000 100% 1.1

Problem: 13-24 Copyright © 1997 Richard D. Irwin, Inc. Printed: 06/21/2024

Fundamentals of Corporate Finance
Ross, Westerfield, and Jordan -- Fifth Edition

Problem 13-27 Objective

Calculate expected return on the market and the risk free rate using the CAPM.

Student Name:
Course Name:
Student ID:
Course Number:

Suppose you observe the following situation:

Expected
Security Beta Return
Spurrier Swamp Co. 1.35 22%

Mumnic Pass Co. 0.90 16%

Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market?
What is the risk-free rate?

Solution
Instructions
Show the solution to this problem below. This involves the simultaneous solution of two unknowns in an
algebraic equation. Show your work as text below.

File: 766207387.xls Copyright © 1997 Richard D. Irwin, Inc. Printed: 06/21/2024