Ch8 Principle of Corporate Finance

CHAPTER 8

Risk and Return

Answers to Practice Questions

1. a. False – investors demand higher expected rates of return on stocks with more nondiversifiable risk.

b. False – a security with a beta of zero will offer the risk-free rate of return.

c. False – the beta will be: (1/3 ( 0) + (2/3 ( 1) = 0.67

d. True.

e. True.

2. In the following solution, security one is ExxonMobil and security two is Coca-Cola. Then:

r1 = 0.10 (1 = 0.182

r2 = 0.15 (2 = 0.273

Further, we know that for a two-security portfolio:

rp = x1r1 + x2r2

(p2 = x12(12 + 2x1x2(1(2(12 + x22(22

Therefore, we have the following results:

|x1 |x2 |rp |(p |(p |(p |

| | | |when ( = 0 |when ( = 1 |when ( = -1 |

|1.0 |0.0 |0.100 |0.182 |0.182 |0.182 |

|0.9 |0.1 |0.105 |0.166 |0.191 |0.137 |

|0.8 |0.2 |0.110 |0.156 |0.200 |0.091 |

|0.7 |0.3 |0.115 |0.151 |0.209 |0.046 |

|0.6 |0.4 |0.120 |0.154 |0.218 |0.000 |

|0.5 |0.5 |0.125 |0.164 |0.228 |0.046 |

|0.4 |0.6 |0.130 |0.179 |0.237 |0.091 |

|0.3 |0.7 |0.135 |0.199 |0.246 |0.137 |

|0.2 |0.8 |0.140 |0.221 |0.255 |0.182 |

|0.1 |0.9 |0.145 |0.246 |0.264 |0.228 |

|0.0 |1.0 |0.150 |0.273...