Chapter 12
Concept Question 4 A) Variance and standard deviation:
Variance is defined as the average square distance between an actual return and the average return. B) Probability of more than one standard deviation:
The empiracle rule of normal distribution the probability of ending up between one standard below and one standard above the average of 68%. The probability of ending up one standard deviation below the average of 34%. The probability will average out to be 50%-34% or 16%. C) Probability:
Mean=6.2
Standard deviation=8.4
P(x>14.6)=P(Z>14.6-6.2/8.4)
P(x>14.6)=P(Z>1)
P(x>14.6)=.16 or 16%
For T Bills
Mean = 3.8
Standard deviation =3.1
P(x>14.6)=P(z>14.6-3.8/3.1)
P(x>14.6)=P(z>3.484)
P (x>14.6)=0.00025
D) Capital: Year to year variability in returns is the basis of second lesson from capital market history. The average risk is rewarded, in a given year, there is a significant chance of dramatic change in value. Chapter 13 Concept Question 3 A) The normal part of the return from the stock is the part of the return that shareholders in the market expect. The second part of return on stock is the risk part, this comes from the unexpected information that gets revealed . B) If shareholders forecast the increase to be 10%, the actual announcement this year is exactly .10 the same as the forecast, this will cause no impact on the stock price, and no one has learned anything.
Chapter 13 Concept Question 8 A) The investment has a positive NPV, it would plot above the SML because of the expected returns are superior to what the financial markets offer the same risk. So in order to determine if an investment has a positive NPS, compare the expected return on the new investment to what the financial market offers on an investment with the same beta. B) Cost of capital is the expected return that is required al all new investments. Expected return on investment is what a company MUST earn on capital investments, just to break even. Referred to the opportunity cost of capital or the required rate of return. It gets calculated on a weighted average basis. Problem 11 % of Money Invested Stock Beta Stock Q 35 0.84 Stock R 25 1.17 Stock S 30 1.11 Stock T 10 1.36 Portfolio Beta=(x1+Bq)+(x2 + Br) + (x3 + Bs) + (x4 + Bt) X1= percentage of money invested in stock q X2= percentage of money invested in stock r X3= percentage of money invested in
