Principles of Managerial Finance

LG5

LG5

LG5

LG5

256 PART 2 Important Financial Concepts

a. On a set of “market return (xaxis)–asset return (yaxis)” axes, use the data

given to draw the characteristic line for asset A and for asset B.

b. Use the characteristic lines from partato estimate the betas for assets A and B.

c. Use the betas found in partbto comment on the relative risks of assets A and B.

5–18 Interpreting beta A firm wishes to assess the impact of changes in the market

return on an asset that has a beta of 1.20.

a. If the market return increased by 15%, what impact would this change be

expected to have on the asset’s return?

b. If the market return decreased by 8%, what impact would this change be

expected to have on the asset’s return?

c. If the market return did not change, what impact, if any, would be expected

on the asset’s return?

d. Would this asset be considered more or less risky than the market? Explain.

5–19 Betas Answer the following questions for assets A to D shown in the following

table.

a. What impact would a 10% increasein the market return be expected to have

on each asset’s return?

b. What impact would a 10% decreasein the market return be expected to have

on each asset’s return?

c. If you were certain that the market return would increasein the near future,

which asset would you prefer? Why?

d. If you were certain that the market return would decreasein the near future,

which asset would you prefer? Why?

5–20 Betas and risk rankings Stock A has a beta of .80, stock B has a beta of 1.40,

and stock C has a beta of .30.

a. Rank these stocks from the most risky to the least risky.

b. If the return on the market portfolio increased by 12%, what change would

you expect in the return for each of the stocks?

c. If the return on the market portfolio decreased by 5%, what change would

you expect in the return for each of the stocks?

d. If you felt that the stock market was just ready to experience a significant

decline, which stock would you probably add to your portfolio? Why?

e. If you anticipated a major stock market rally, which stock would you add to

your portfolio? Why?

5–21 Portfolio betas Rose Berry is attempting to evaluate two possible portfolios,

which consist of the same five assets held in different proportions. She is particu-

Asset Beta

A.50

B 1.60

C .20

D.90