Complete the following problems in either Microsoft Word or Excel.

Your work must be organized. Highlight your final answer.

Question1:

Part 1: The following table shows the nominal returns on U.S. stocks and the rate of inflation.       

a. What was the standard deviation of the market returns?

b. Calculate the average real return.

          Year                      Nominal Return (%)                 Inflation (%)

          2004                               +12.5                                        +3.3

          2005                               +6.4                                         +3.4

          2006                               +15.8                                        +2.5

          2007                               +5.6                                         +4.1

          2008                               -37.2                                        +0.1

Part 2: Suppose the standard deviation of the market return is 20%.

a. What is the standard deviation of returns on a well-diversified portfolio with a beta of 1.3?

b. What is the standard deviation of returns on a well-diversified portfolio with a beta of 0?

c. A well-diversified portfolio has a standard deviation of 15%. What is its beta?

d. A poorly diversified portfolio has a standard deviation of 20%. What can you say about its beta?

Question 2:

          Stock                              Beta                      Expected Return

          Amazon                          2.16                                15.4

          Ford                                1.75                                12.6

          Dell                                1.41                                10.2

          Starbucks                        1.16                                8.4

          Boeing                            1.14                                8.3

          Disney                            .96                                  7.0

          Newmont                        .63                                  4.7

          Exxon Mobil                             .55                                  4.2

          Johnson & Johnson                  .50                                  3.8

          Campbell Soup                .30                                  2.4

Part 1: Suppose that the Treasury bill rate were 6% rather than 4%. Assume that the expected return on the market stays at 10%. Use the betas above.

a. Calculate the expected return from Dell.

b. Find the highest expected return that is offered by one of these stocks.

c. Find the lowest expected return that is offered by one of these stocks.

d. Would Ford offer a higher or lower expected return if the interest rate were 6% rather than 4%? Assume that the expected market return stays at 10%.

e. Would Exxon Mobil offer a higher or lower expected return if the interest rate were 8%?

Part 2: Consider a three-factor APT model. The factors and associated risk premiums are:

                   Factor                                                Risk Premium

          Change in GNP                                            5%

          Change in energy prices                               -1

          Change in long-term interest rates                +2

Calculate expected rates of return on the following stocks. The risk-free interest rate is 7%.

a. A stock whose return is uncorrelated with all three factors.

b. A stock with average exposure to each factor (i.e., with b = 1 for each).

c. A pure-play energy stock with high exposure to the energy factor (b = 2) but zero expo- sure to the other two factors.

d. An aluminum company stock with average sensitivity to changes in interest rates and GNP, but negative exposure of b = -1.5 to the energy factor. (The aluminum company is energy-intensive and suffers when energy prices rise.)