Stock A has a beta of 0.8 and an expected return of 0.084. Stock B has...

  

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Stock A has a beta of 0.8 and an expected return of 0.084. Stock B has a beta of 1.5 and an expected return of 0.14. (i) Assuming that the CAPM holds, what is the risk-free rate and expected return of the market? [3 marks] (ii) If Stock C has a beta of 2 and expected return of 0.2, does CAPM still hold? Would an investor want to be long or short Stock C? Explain. [2 marks] (b) An investor is considering two investments. The first investment is a perpetuity that pays 500 at the end of each odd year and 750 at the end of each even year. The second in- vestment is a growing annuity that pays 400 at the end of the year, has an annual growth rate of 2% and has a final payment in 50 years. The term structure is flat at 5% per year. Which investment should the investor choose? Explain. [5 marks] (c) You are a bond trader and observe that the current one-year spot rate is 2% and the current two-year spot rate is 4%. If the term structure stays the same for a year, what is the one- year return on a default-free two-year 15% annual coupon bond with a par value of 1000? [5 marks] (d) When there is an increase in the short-term interest rate, does it have a greater effect on longer-term government bond prices or on shorter-term government bond prices, holding everything else constant? Explain. [5 marks] (e) There are N securities in the market. All securities have a variance of 0.1, and the corre- lation between every pair of securities is 0.5. An investor wants to construct an equally weighted portfolio which has a variance of 0.052. How many securities does the investor need to include in their portfolio to fulfil this requirement? [5 marks] Stock A has a beta of 0.8 and an expected return of 0.084. Stock B has a beta of 1.5 and an expected return of 0.14. (i) Assuming that the CAPM holds, what is the risk-free rate and expected return of the market? [3 marks] (ii) If Stock C has a beta of 2 and expected return of 0.2, does CAPM still hold? Would an investor want to be long or short Stock C? Explain. [2 marks] (b) An investor is considering two investments. The first investment is a perpetuity that pays 500 at the end of each odd year and 750 at the end of each even year. The second in- vestment is a growing annuity that pays 400 at the end of the year, has an annual growth rate of 2% and has a final payment in 50 years. The term structure is flat at 5% per year. Which investment should the investor choose? Explain. [5 marks] (c) You are a bond trader and observe that the current one-year spot rate is 2% and the current two-year spot rate is 4%. If the term structure stays the same for a year, what is the one- year return on a default-free two-year 15% annual coupon bond with a par value of 1000? [5 marks] (d) When there is an increase in the short-term interest rate, does it have a greater effect on longer-term government bond prices or on shorter-term government bond prices, holding everything else constant? Explain. [5 marks] (e) There are N securities in the market. All securities have a variance of 0.1, and the corre- lation between every pair of securities is 0.5. An investor wants to construct an equally weighted portfolio which has a variance of 0.052. How many securities does the investor need to include in their portfolio to fulfil this requirement? [5 marks]