Fin 534 Chapter 3 Homework

 

Again, looking at Standard Deviation for my friend. Because she is already highly risk averse (which means that she dislikes risk), I would choose Stock B because the SD is 8%. This is a safer bet for her low risk portfolio.

3. Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE? a. Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the "true" or "expected future" beta. b. The beta of an "average stock," or "the market," can change over time, sometimes drastically. c. Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. d. All of the statements above are true. e. The fact that a security or project may not have a past history that can be used as the basis for calculating beta.

Explanation: In section 6-

7b, we learn that “a firm can influence its beta through changes on the

composition of its assets and also through its use of debt: Acquiring riskier assets will increase beta, as will a change in capital structure that calls for a higher debt ratio. A

company’s beta can also change as a result of external factors such as increased

competition in its industry, the expiration of basic patents, and the like. When such

changes lead to a higher or lower beta, the required rate of return will also change”

(Brigham & Ehrhardt, 2014).

4. Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these securities? (Assume market equilibrium.) a. Stock B must be a more desirable addition to a portfolio than A. b. Stock A must be a more desirable addition to a portfolio than B. c. The expected return on Stock A should be greater than that on B. d. The expected return on Stock B should be greater than that on A. e. When held in isolation, Stock A has more risk than Stock B.

Explanation:

“A stock with a high standard deviation, will tend to have a high beta”, which can lead to

a higher rate of return (Brigham & Ehrhardt, 2014)

. Therefore, with Stock A’s beta at

1.7, then we should expect a greater rate of return for Stock A compared to Stock B.

5. Which of the following statements is CORRECT? a. If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. b. The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. c. The beta of a portfolio of stocks is always larger than the betas of any of the individual

FIN 534 – Financial ManagementHomework Set #3: Chapters 6, 7, & 8Due Week 6 and worth 100 pointsDirections: Answer the following questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculationis needed, or both. Submit your assignment using the assignment link above.A. Using the two stocks you selected from Homework #1, identify the Beta for each stock. In your own words, what conclusion can you draw from the stocks’ current and historical beta? If the stock market went up 10% today, what would be the impact on each of your stocks?The two stocks I selected in Assignment 1 were Adobe Systems Inc.,(ADBE) and Alaska Air Group, Inc. (ALK) The beta for ADBE is currently 1.03 and the beta for ALK is currently 0.69. From the beta, which tell me the volatility of the stock in relation to the market, I learn that ALK stock is a lot less volatile

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