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# Account Question - Answers

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Question 1
1.
Nile Foods' stock has a beta of 1.4, while Elbe Eateries' stock has a beta of 0.7. Assume that the
risk-free rate, r
RF
, is 5.5% and the market risk premium, (r
M
 r
RF
), equals 4%. Which of the
following statements is CORRECT?
Since Nile's beta is twice that of Elbe's, its required rate of return will also be twice that of
Elbe's.
If the risk-free rate increases but the market risk premium remains unchanged, the required
return will increase for both stocks but the increase will be larger for Nile since it has a
higher beta.
If the market risk premium increases but the risk-free rate remains unchanged, Nile's
required return will increase because it has a beta greater than 1.0 but Elbe's will decline
because it has a beta less than 1.0.
If the market risk premium decreases but the risk-free rate remains unchanged, Nile's
required return will decrease because it has a beta greater than 1.0 and Elbe's will also
decrease, and by more than Nile's because it has a beta less than 1.0.
If the risk-free rate increases while the market risk premium remains constant, then the
required return on an average stock will increase.
3 points
Question 2
1.
A stock is expected to pay a dividend of \$1.00 at the end of the year (i.e., D
1
 \$1.00), which is
expected to grow 25% in each of the following two years and at a constant rate of 6%, thereafter.
If the stock's required return is 11%, what is the stock's price today?
D
1
=\$1.00
D
2
= D
1
(1 + g)
=\$1.00(1.25)
=\$1.25
D
3
= D
2
(1 + g)
=\$1.25(1.25)
=\$1.5625
D
4
= D
3
(1 + g)

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=\$1.5625(1.06)
=\$1.6525
P
3
= D
4
/(r
s
+ g
n
)
=\$1.6525/0.11-0.06
=\$33.125
P
0
= {1/(1.11)} + {1.25/(1.11
2
)} + ([33.125 + 1.5625]/(1.11)
3
}
=\$27.28
\$26.1
4
\$27.2
8
\$30.4
8
\$32.7
1
\$35.3
8
3 points
Question 3
1.
You hold a diversified portfolio consisting of a \$5,000 investment in each of 20 different
common stocks. The portfolio beta is equal to 1.15. You have decided to sell one of your stocks,
a lead mining stock whose b is equal to 1.0, for \$5,000 net and to use the proceeds to buy \$5,000
of stock in a steel company whose beta is equal to 2.0. What will be the new beta of the
portfolio?
b
p
= W
1
b
1
+ W
2
b
2
+ W
3
b
3
+ ……. W
n
b
n
let W
19
b
19
be sum of the other 19 stocks
1.15= W
19
b
19
+ (0.05 * 1.0)
W
19
b
19
= 1.10
b
p
= 1.10 + (0.05 * 2)
= 1.20
1.1
2
1.2

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0
1.2
2
1.1
0
1.1
5
3 points
Question 4
1.
Stock A has a beta  0.8, while Stock B has a beta  1.6. Which of the following statements is
CORRECT?
Stock B's required return is double that of Stock A's.
An equally weighted portfolio of Stock A and Stock B will have a beta less than 1.2.
If market participants become more risk averse, the required return on Stock A will increase
more than the required return for Stock B.
If market participants become more risk averse, the required return on Stock B will increase
more than the required return for Stock A.
If the risk-free rate increases but the market risk premium remains constant, the required
return on Stock A will increase by more than that on Stock B.
3 points
Question 5
1.
Stock A has a beta of 0.8 and Stock B has a beta of 1.2. Fifty percent of Portfolio P is invested in
Stock A and fifty percent is invested in Stock B. If the market risk premium (r
M
 r
RF
) were to
increase but the risk-free rate (r
RF
) remained constant, which of the following would occur?
The required return will decrease by the same amount for both Stock A and Stock B.
The required return will increase for both stocks but the increase will be greater for Stock B
than for Stock A.
The required return will increase for Stock A but will decrease for Stock B.
The required return will increase for Stock B but will decrease for Stock A.
The required return on Portfolio P will remain unchanged.

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