solutions Week 2.pptVIP

* * Week 2 Solutions Q8.10 Here are inflation rates and U.S. stock market and Treasury bill returns between 1929 and 1933: a. What was the real return on the stock market in each year? b. What was the average real return? c. What was the risk premium in each year? d. What was the average risk premium? e. What was the standard deviation of the risk premium? 8.10 a Fisher equation: (1 + rnominal) = (1 + rreal) ? (1 + inflation rate) Therefore: rreal = [(1 + rnominal)/(1 + inflation rate)] – 1 a. The real return on the stock market in each year was: 8.10 b - d 10.8 e 8.14 Lonesome Gulch Mines has a standard deviation of 42% per year and a beta of .10. Amalgamated Copper has a standard deviation of 31% a year and a beta of .66. Explain why Lonesome Gulch is the safer investment for a diversified investor. 8.22 There are few, if any, real companies with negative betas. But suppose you found one With -.25. a. How would you expect this stock’s rate of return to change if the overall market rose by an extra 5%? What if the market fell by an extra 5%? 8.22 a a. In general, we expect a stock’s price to change by an amount equal to (beta ? change in the market). Beta equal to –0.25 implies that, if the market rises by an extra 5%, the expected change in the stock’s rate of return is –1.25%. If the market declines an extra 5%, then the expected change is +1.25%. 8.22 b b. You have $1 million invested in a well-diversified portfolio of stocks. Now you receive an additional $20,000 bequest. Which of the following actions will yield the safest overall portfolio return? i. Invest $20,000 in Treasury bills (which have beta = 0). ii. Invest $20,000 in stocks with beta = 1. iii. Invest $20,000 in the stock with beta = -0.25. Explain your answer. 8.22 b . “Safest” implies lowest risk. Assuming the well-diversified portfolio is invested in typical securities, the portfolio beta is approximately one. The largest reduction in beta is achieved by investing the $20,000 in a