Suppose you consider buying a share of stock at $40

The study is undertaken to find out the relationship between portfolio returns and market returns and test the empirical validity of the standard CAPM model on Bahrain Bourse. The study is based on 39 companies listed in the Bahrain Bourse, Bahrain All Share Index as market proxy and yield of Government of Bahrain securities as risk free rate of return. The study covers period from January 1, 2011 to December 31, 2014. The analysis of the results of the study revealed that many of the independent variables together with beta can explain the portfolio returns. However, the intercept test reveals that the portfolio returns are equal to the risk-free rate of return. Therefore, we can conclude that the results of intercept test of standard CAPM proves the theory and the beta test results goes against the standard theory.

Suppose the yield on short-term government securities (perceived to be risk-free) is about 4%. Suppose also that the expected return required by the market for a portfolio with a beta of 1 is 12%. According to the capital asset pricing model:

a. What is the expected return on the market portfolio?

b. What would be the expected return on a zero-beta stock?

c. Suppose you consider buying a share of stock at a price of $40. The stock is expected to pay a dividend of $3 next year and to sell then for $41. The stock risk has been evaluated at β = - .5. Is the stock overpriced or underpriced?

The correct answer would be:

a. 12%

b. 4%

c. Underpriced

FNCE 30001 – Investments

Buying and Selling and Margin Trading

Problem Set

Due the week of 10 August 2020

This week’s Homework and Tutorial is UNMARKED

Normally

, there will be a mixture of marked and unmarked questions to provide a few more topics to cover

during your tutorials. Please read the directions each week! It can affect your mark! Because this entire assignment

is unmarked this week, I am not distinguishing marked from unmarked as it all unmarked.

Feel free to check your work in Excel (in fact, I encourage it), but please do the questions by

hand. Why? It forces you to think more, and hopefully more about the economic intuition and

to better understand what you are doing.

1. Assume you bought a stock for $50 and it has increased to $75. You think it may go

higher, but you want to protect most of your current profit. What order would you place

to ensure a minimum gain of about $23 per share?

Emphasis here on the word “about”. I’d put a stop sell order at $73, since $73 - $50 is

$23. Keep in mind, that the stop sell order sets the price at which a trade is triggered, it

does not guarantee you will get that price with certainty, though it usually will be very

close.

2. On 15 August you purchased 100 shares in the Cara Cotton Company at $65 a share and

a year later you sold them for $61 a share. During the year, you received dividends of $3

per share. Please compute the realized holding period return. (Hint: you’ve been given no

information about the timing of the dividends and no information about prices during the year, so assume

that the $3 is received and not reinvested – or equivalently assume you receive it at the end of the year.)

The fact there are 100 shares doesn’t affect the return calculation so I am ignoring it,

because I thought it was easier to type this sentence than to ×100 twice in the

numerator and once in the denominator.

Return=Revenue−Cost

Cost

Return=$61+$3−$65

$65=−0.0154 𝑜𝑟−1.54%