1.You must choose between investing in Stock A or Stock B. You have already used CAPM to calculate the rate of return you should expect to receive for each stock given each one's systematic risk and decided that the expected return for both exceeds that predicted by CAPM by the same amount. In other words, both are equally attractive investments for a diversified investor. However, since you are still in school and do not have a lot of money, your investment portfolio is not diversified. You have decided to invest in the stock that has the highest expected return per unit of total risk.

If the expected return and standard deviation of returns for Stock A are 11 percent and 30 percent, respectively, and the expected return and standard deviation of returns for Stock B are 20 percent and 40 percent, respectively, which should you choose? Assume that the risk-free rate is 5 percent. (Round answers to 3 decimal places, e.g. 52.750.)

Stock AStock B

a.Highest expected return per unit of risk__________ __________

b.Should you invest in (Stock-A OR Stock-B) because it has the (Highest OR Lowest) expected return per unit of risk?

2.The CEO of Coral Gables Corp. was reviewing the returns of the company's sizeable investment portfolio in the last five years during a period of extreme volatility. He noted the 5 year sequence of investment returns as follows: +30%, -20%, +30%, -20%, +30%. He then calculated the arithmetic average return, but his CFO noted that since he had ignored the compounding effect he was wrong. By how much was he wrong? (Hint: Calculate the annual arithmetic average return over the five years less the average geometric (compounded) return.)

a 3.25%b 9.39% c 1.59%d 2.95%

3.Calculate the geometric average return earned by an investor over three years if she earned 6% in the first year of an investment, 12% in the second year and 10% in the third year.

a 9.33%b 9.30%c 9.36%d 9.27%

4. Cullumber, Inc., stock has a beta of 1.30. If the expected market return is 15.0 percent and the risk-free rate is 4.0 percent, what does CAPM indicate the appropriate expected return for Cullumber stock is? (Round answer to 2 decimal places, e.g. 52.75.)