Characteristic Line and Security Market Line You are given the following set of data: a. Use a

Question:

Characteristic Line and Security Market Line You are given the following set of data:

Historical Rates of Return Stock X Year NYSE 1 (26.5%) (14.0%) 37.2 23.0 23.8 17.5 (7.2) 2.0 6.6 8.1 19.4 20.5 30.6 18.2

a. Use a spreadsheet (or a calculator with a linear regression function) to determine Stock X’s beta coefficient.

b. Determine the arithmetic average rates of return for Stock X and the NYSE over the period given. Calculate the standard deviations of returns for both Stock X and the NYSE.

c. Assuming (1) that the situation during Years 1 to 7 is expected to hold true in the future (that is. rx = rx; rM = rM; and both σX and bX in the future will equal their past values), and (2) that Stock X is in equilibrium (that is, it plots on the Security Market Line), what is the risk-free rate?

d. Plot the Security Market Line.

e. Suppose you hold a large, well-diversified portfolio and are considering adding to the portfolio either Stock X or another crock. Stock Y, which has the came beta as Stock X but a higher standard deviation of returns. Stocks X and Y have the same expected returns; that is, rX = rY = 10.6%. Which crock should you choose?

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