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P8-20. Interpreting beta
LG 5; Basic
Effect of change in market return on asset with beta of 1.20:
a. 1.20 (15%) 18.0% increase
P8-21. Betas
LG 5; Basic
a. and b.
Asset Beta
Increase in
Market Return
Expected Impact
on Asset Return
Decrease in
Market Return
Impact on
Asset Return
A 0.50 0.10 0.05 0.10 0.05
c. Asset B should be chosen because it will have the highest increase in return.
d. Asset C would be the appropriate choice because it is a defensive asset, moving in opposition to the
P8-22. Personal finance: Betas and risk rankings
LG 5; Intermediate
a.
Stock Beta
Most risky B 1.40
b. and c.
Asset Beta
Increase in
Market Return
Expected Impact
on Asset Return
Decrease in
Market Return
Impact on
Asset Return
A 0.80 0.12 0.096 0.05 0.040
d. In a declining market, an investor would choose the defensive stock, Stock C. While the market
e. In a rising market, an investor would choose Stock B, the aggressive stock. As the market rises one
© 2015 Pearson Education, Inc.
P8-23. Personal finance: Portfolio betas: bp
1
n
j j
j
w b
=
´
å
LG 5; Intermediate
a.
Portfolio A Portfolio B
Asset Beta wAwAb
A
wBwBb
B
1 1.30 0.10 0.130 0.30 0.39
b. Portfolio A is slightly less risky than the market (average risk), while Portfolio B is more risky than
P8-24. Capital asset pricing model (CAPM): rj RF [bj(rm RF)]
LG 6; Basic
Case rjRF [bj(rm RF)]
A 8.9% 5% [1.30(8% 5%)]
P8-25. Personal finance: Beta coefficients and the capital asset pricing model
LG 5, 6; Intermediate
To solve this problem you must take the CAPM and solve for beta. The resulting model is
Beta
F
m F
r R
r R
-
=-
a.
10% 5% 5%
Beta 0.4545
16% 5% 11%
-
= = =
-
b.
15% 5% 10%
Beta 0.9091
16% 5% 11%
-
= = =
-
c.
18% 5% 13%
Beta 1.1818
16% 5% 11%
-
= = =
-
d.
20% 5% 15%
Beta 1.3636
16% 5% 11%
-
= = =
-
e. If Katherine is willing to take a maximum of average risk then she will be able to have an expected
P8-26. Manipulating CAPM: rj RF [bj(rm RF)]
LG 6; Intermediate
a. rj8% [0.90(12% 8%)]
b. 15% RF [1.25(14% RF)]
c. 16% 9% [1.10(rm 9%)]
d. 15% 10% [bj(12.5% 10%)
P8-27. Personal finance: Portfolio return and beta
LG 1, 3, 5, 6: Challenge
a. bp (0.20)(0.80) (0.35)(0.95) (0.30)(1.50) (0.15)(1.25)
b. rA
($20,000 $20,000) $1,600 $1,600 8%
$20,000 $20,000
- +
= = =
rB
($36,000 $35,000) $1,400 $2,400 6.86%
$35,000 $35,000
- +
= = =
rC
($34,500 $30,000) 0 $4,500 15%
$30,000 $30,000
- +
= = =
rD
($16,500 $15,000) $375 $1,875 12.5%
$15,000 $15,000
- +
= = =
c. rP
($107,000 $100,000) $3,375 $10,375 10.375%
$100,000 $100,000
- +
= = =
d. rA 4% [0.80(10% 4%)] 8.8%
e. Of the four investments, only C (15% vs. 13%) and D (12.5% vs. 11.5%) had actual returns that
P8-28. Security market line, SML
LG 6; Intermediate
c. rj RF [bj(rm RF)]
Asset A
d. Asset A has a smaller required return than Asset B because it is less risky, based on the beta of 0.80
P8-29. Shifts in the security market line
LG 6; Challenge
a, b, c, d.
b. rj RF [bj(rm RF)]
c. rA 6% [1.1(10% 6%)]
d. rA 8% [1.1(13% 8%)]
e. (1) A decrease in inflationary expectations reduces the required return as shown in the parallel
P8-30. Integrative—risk, return, and CAPM
LG 6; Challenge
a.
Project rjRF [bj(rm RF)]
Arj9% [1.5(14% 9%)] 16.50%
b. and d.
c. Project A is 150% as responsive as the market.
d. See graph for new SML.
e. The steeper slope of SMLb indicates a higher risk premium than SMLd for these market conditions.
P8-31. Ethics problem
LG 1; Intermediate
Investors expect managers to take risks with their money, so it is clearly not unethical for managers to
Case
Case studies are available on www.myfinancelab.com.
Analyzing Risk and Return on Chargers Products’ Investments
This case requires students to review and apply the concept of the risk-return tradeoff by analyzing two possible
a. Expected rate of return:
1
1
( )
t t t
t
t
P P C
rP
-
-
- +
=
Asset X:
Year
Cash
Flow (Ct)
Ending
Value (Pt)
Beginning
Value (Pt – 1)
Gain/
Loss
Annual Rate
of Return
2006 $1,000 $22,000 $20,000 $2,000 15.00%
Asset X: (continued)
Year
Cash
Flow (Ct)
Ending
Value (Pt)
Beginning
Value (Pt – 1)
Gain/
Loss
Annual Rate
of Return
2010 1,900 23,000 22,000 1,000 13.18
Average expected return for AssetX 11.74%
Asset Y:
Year
Cash
Flow (Ct)
Ending
Value (Pt)
Beginning
Value (Pt – 1)
Gain/
Loss
Annual Rate
of Return
2006 $1,500 $20,000 $20,000 $ 0 7.50%
Average expected return for Asset Y 11.14%
b. r
2
1
( ) ( 1)
n
i
i
r r n
=
- ¸ -
å
Asset X:
Year
Return
ri
Average
Return, r
( )-
i
r r
( )-
i
r r
2
2006 15.00% 11.74% 3.26% 0.001063
Asset X: (continued)
Year
Return
ri
Average
Return, r
( )-
i
r r
( )-
i
r r
2
2012 2.69 11.74 9.05 0.008190
0.071297 0.07922 0.0890 8.90%
10 1
x
s= = = =
-
8.90% 0.76
11.74%
CV = =
Asset Y:
Year Return
ri
Average
Return, r
( )-
i
r r
( )-
i
r r
2
2006 7.50% 11.14% 3.64% 0.001325
0.006955 0.0773 0.0278 2.78%
10 1
Y
s= = = =
-
2.78% 0.25
11.14%
CV = =
c. Summary statistics:
Asset X Asset Y
Expected return 11.74% 11.14%
d. Using the capital asset pricing model, the required return on each asset is as follows:
Capital asset pricing model: rj RF [bj(rm RF)]
Asset RF [bj(rm RF)] rj
X 7% [1.6(10%
11.8%
e. In part c, we concluded that it would be difficult to make a choice between X and Y because the additional
f. 1. Increase in risk-free rate to 8% and market return to 11%:
Asset RF [bj(rm RF)] rj
X 8% [1.6(11%
12.8%
8%)]
2. Decrease in market return to 9%:
Asset RF [bj(rm RF)] rj
X 7% [1.6(9% 7%)] 10.2%
Spreadsheet Exercise
The answer to Chapter 8’s stock portfolio analysis spreadsheet problem is located on the Instructor’s Resource
Group Exercise
Group exercises are available in www.myfinancelab.com.
This exercise uses current information from several websites regarding the recent performance of each group’s
s
