Explain the interactions among market efficiency, capital budgeting, and the cost of capital.

Explain the interactions among market efficiency, capital budgeting, and the cost of capital.

 

3. Give two examples of anomalies in the financial markets.

 

1. What does the existence of these anomalies say about financial market efficiency?

 

3. Use the following information to answer the questions below.

Security	Return	Standard Deviation	Beta
A	15%	8%	1.2
B	12%	14%	0.9

 

1. Which of A and B has the least total risk? The least systematic risk?
2. What is the value of systematic risk for a portfolio with 75% of the funds invested in A and 25% of the funds invested in B?
3. Calculate the risk free rate of return and the market risk premium
   (i.e., R_f and R_M – R_f).
4. What is the portfolio expected return and the portfolio beta if you invest 30% in A, 30% in B, and 40% in the risk-free asset?
   (For questions (d) and (e), assume the risk free rate of return is 5%.)
5. What is the portfolio expected return with 125% invested in A and the remainder in the risk-free asset via borrowing at the risk-free interest rate?
6. What is the beta of the portfolio created in part (e)?
7. Consider the following information on three stocks.

 

		Rate of Return if State Occurs
State of economy	Probability of state of economy	Stock A	Stock B	Stock C
Boom	0.5	0.2	0.35	0.6
Normal	0.3	0.15	0.12	0.05
Bust	0.2	0.01	-0.25	-0.5

 

1. If your portfolio is invested 40% each in A and C, and 20% in B, what is the portfolio expected return?

 

1. What is the variance of this portfolio?

 

1. What is the standard deviation of this portfolio?

 

1. If the expected T-Bill rate is 5%, what is the expected risk premium on the portfolio?

 

2. If the expected inflation rate is 2.50%, what are the approximate and exact expected real returns on the portfolio?

 

2. If the expected T-Bill rate is 5% and the expected inflation rate is 2.50%, what are the approximate and exact expected real risk premiums on the portfolio?