Dexter ltd is planning to raise money from the capital markets. Sensex is expected to give 10% return in the last one year. The 10-year government yield going rate is 8%. The Covariance of the Rm and IPOs is 0.12 and their market variance is 0.9. Calculate the cost of equity based on CAPM model
Dexter ltd is planning to raise money from the capital markets. Sensex is expected to give 10% return in the last one year. The 10-year government yield going rate is 8%. The Covariance of the Rm and IPOs is 0.12 and their market variance is 0.9. Calculate the cost of equity based on CAPM model
Related questions
Selena invests the following sum of money in common stock having expected returns as follows:
| Common Stock | Amount Invested in $ | Expected Return | Beta of Stock β |
| WOOPS | 5,000 | 0.14 | 0.6 |
| KBOOM | 10,000 | 0.16 | 0.8 |
| JUDY | 6,000 | 0.17 | 0.85 |
| UPDWN | 8,000 | 0.13 | 0.5 |
| SPROUT | 4,500 | 0.20 | 1.1 |
| RINGG | 7,500 | 0.15 | 0.65 |
| EIEIO | 9,000 | 0.18 | 0.9 |
a) What is the expected return on her portfolio based on the amount invested above?
b) Calculate the systematic risk, β of the portfolio.
c) Does the portfolio have more or less systematic risk compared to the average market portfolio?
d) If return on the market (Rm) is 14% and the risk free rate (Rf) is 4%, what would be the return of the portfolio according to Capital Asset Pricing Model (CAPM)?
e) If Selena wants to get 12% return from this portfolio, is this the appropriate portfolio for her? Explain your reason using your answer in (A) and (D).
f) If she still wants to invest in this portfolio, what should she do in terms of adjusting the weight of the stock? Give your answer based on the amount invested in UPDWN and SPROUT stocks.
CONCEPTS IN THIS CASE
expected return
risk
portfolio choice
diversification
systematic risk
nonsystematic risk
beta
capital asset pricing model
arbitrage pricing
Your supervisor has asked that you quantify the effects of diversification using three potential portfolios. The information given regarding each portfolio is as follows:
| Probability | Return (%) on | Return (%) on | Return (%) on |
| .20 | 8 | 24 | 16 |
| .30 | 10 | 16 | 10 |
| .30 | 12 | 12 | 12 |
| .20 | 14 | 17 | 6 |
Using the information above, calculate the following for each individual security:
What is the expected return for security A?
What is the expected return for security B?
What is the expected return for security C?
What is the variance of the return for security A?
What is the variance of the return for security B?
What is the variance of the return for security C?
Using the information above, calculate the following for each pair of securities:
What is the covariance of securities A and B?
What is the covariance of securities A and C?
What is the covariance of securities B and C?
If your firm makes equal investments in securities A and B (50% in each):
What is the expected return of the portfolio that combines A and B?
What is the variance of the portfolio that combines A and B?
If your firm makes equal investments in securities A and C (50% in each):
What is the expected return of the portfolio that combines A and C?
What is the variance of the portfolio that combines A and C?
If your firm makes equal investment in securities B and C (50% in each):
What is the expected return of the portfolio that combines B and C?
What is the expected variance of the portfolio that combines B and C?
Given the results of your work in questions 3, 4, and 5 above, which portfolio would you recommend to your supervisor? Explain.
You have searched online resources and found the beta of each security. Security A has a beta of 1.0, security B has a beta of .50 and security C has a beta of 1.50. If the risk-free interest rate is 5% and the expected return for the market portfolio is 12%:
What is the CAPM risk premium for security A?
What is the CAPM risk premium for security B?
What is the CAPM risk premium for security C?
How would your definition of the risk premium change if you used the Arbitrage Pricing Theory (APT) equation?
