Risk and Return Questions-K

1. Price at the beginning of the year: Rs.
60
Dividend paid at the end of the year: Rs.2.40
Price at the end of the year: Rs.69
The total return on the stock is: ?
Holding Period Return= [D+(P1-P0)]/P0= 19%
2. The stocks of Suburban Travellers’ Ltd. are currently trading at Rs.50 per share and
are expected to pay a dividend of Rs.2.00 per share in this year. The stock price
expected one year hence has the following probability distribution:
Probability 0.35 0.40 0.25
Price (Rs.) 52 56 62
Ignoring the time value of the dividend income, find the expected return from that stock
for a holding period of one year .
P1=?
P1=∑Pi*Ri= 0.35*52+0.4*56+0.25*62= Rs 56.1
Holding Period Return= [D+(P1-P0)]/P0= 16.2%
3. The following information is available in respect of the return from security X under
different economic conditions:
Economic conditions Return Probability
Prosperity 22% 0.1
Normal 18% 0.4
Recession 12% 0.3
Depression 6% 0.2
What is the risk associated with this security?
Variance=P*(R-Ravg)^2
Ravg or Expected Return= Prob*Return= 0.1*22+0.4*18+0.3*12+0.2*6= 14.2%
Variance= 0.1*(22-14.2)^2+0.4*(18-14.2)^2+0.3*(12-14.2)^2+0.2*(6-14.2)^2=
26.76(%)^2
Std Dev= 5.2%
4. The correlation coefficient between the returns on the equity shares of ABC Ltd and
the market return is 0.90. The variance of return on equity shares of the company is
49(%)^2 and the same for the market is 36(%)^2. Presently the government securities
are traded at a return of 5.5% while the market return is 12%. What is required rate of
return from the equity shares of the above company?
Correlation=0.9, Variance of stock=49(%)^2, Variance of market=36(%)^2, Rf=5.5%,

Rm=12%, Ke=?
Beta= Covariance/Variance of market
Covariance= Correlation*std dev of stock*std dev of market
Covariance= 0.9*7*6=37.8, Beta= 37.8/36= 1.05
Ke= 12.32%
Eg- Rm=12%, Beta of stock =1, Rs=?
5. Mr. Amit is seeking to know whether the security of SAT Industries Ltd, is correctly
priced or not. The following details are available about the stock: The standard
deviation of the stock is 24 percent. The correlation coefficient for the security with
the market is 0.8 and the market standard deviation is 16 percent. The return from the
Government Securities is 6.5 percent and that from the market portfolio is 10.5
percent. If the expected return on the stock is 12.5%, find the required return on the
security and identify whether it is rightly priced or not.
Std dev of stock=24%, Correl= 0.8, Std dev of market= 16%, Rf=6.5%, Rm= 10.5%
Historical return=12.5%, Ke=?
Beta=?
Beta= Covariance/Variance of market
Covariance= Correlation*std dev of stock*std dev of market=307.2
Beta=307.2/256=1.2
Ke= 11.3%
Alpha= 12.5-11.3= 1.2, positive, Undervalued, Above SML
6. The following information is given with respect to Foren Kapital Services Ltd.
Last year dividend Rs.2.00 per share
Constant rate of growth in dividends (%) 5
Expected return from the market index (%) 12
Beta of the stock 1.50
Risk free rate of return (%) 6
The present market price per share will be approximately equal to
D0=2, g=5%, Rm=12%, Beta=1.5, Rf=6%, P0=?
Ke= Rf+(Rm-Rf)*Beta= 15%
P0=D1/(Ke -g)= Rs 21(Intrinsic Value)
Market Price =Rs 25
7. Following information is provided:
Stock A B
Expected 32% 27%
return
Beta 1.5 0.7
CAPM 20+(28-20)*1.5=32% 20+(28-20)*0.7=25.6%
Correctly Priced, on SML Undervalued, BUY, Above SML
Returns of T- Bill is 20% and return of Sensex is 28%. Calculate the return as per
CAPM for each of the company’s stock. Identify whether they are underpriced,
overpriced or correctly priced and advise accordingly.
Alpha = Expected Return - CAPM Return
Positive----Undervalued
Negative---Overvalued
8. Neha is seeking to know whether the security of ABC Ltd, is correctly priced or not.
The following details are available about the stock: The standard deviation of the
stock is 27 percent. The correlation coefficient for the security with the market is 0.75
and the market standard deviation is 20 percent. The return from the Government
Securities is 8 percent and that from the market portfolio is 22 percent. If the expected
return on the stock is 19%, find the required return as per CAPM and advise.
9. Returns of T- Bill is 7%. Calculate the return as per CAPM for each of the company’s
stock. Identify whether they are underpriced, overpriced or correctly priced and
advise accordingly.
Stock Expected Beta CAPM Return

Return(Historical
Data)
Infosys 24% 0.7 7+(15-7)*0.7=12.6%
Undervalued,
BUY,Above SML
HUL 19% 0.5 11%
Undervalued,
BUY,Above SML
Reliance 11% 1.2 16.6%

Industries
Overvalued, Sell,
Below SML
SBI 15% 1.2 16.6%
Overvalued, Sell
Sensex(Market) 15% 1
10. Consider the following information:

Expected return on market 15%
Required rate of return on stock X as per 13.2%
CAPM
Beta of stock X 0.8
Expected rate of return on stock X 15%
Is the stock underpriced or overpriced?

Undervalued
11. Security AB is expected to incur the forecasted returns as shown below:
Market condition Probability Stock market Return on security
return AB
Stagnant 0.30 (20%) (25%)
Slow growth 0.40 20% 25%
Average growth 0.20 35% 45%
Rapid growth 0.10 50% 60%
The risk free return prevailing in the market is currently 6%.
a) Determine the expected returns on the stock market and on security AB.
Return= Prob*Return
Market Return= 0.3*(20)+0.4*20+0.2*35+0.1*50= 14%
Stock return= 0.3*(25)+0.4*25+0.2*45+0.1*60= 17.5%
Stock has overperformed
b) What is security AB’s beta, if correlation between stock and market is 0.85
Beta=Correlation*Std Dev of Stock/ Std Dev of Market
Beta= Covariance/Variance of market=1.06
Covariance= Correlation*std dev of stock*std dev of market
Std dev of market=24.06%, std dev of stock= 29.94%

Variance=P*(R-Ravg)^2
c) Determine the required return on the security AB according to the CAPM.

Ke= 6+(14-6)*1.06=14.48%
12. Amita has the following stocks in her portfolio:
Beta Proportion of
investment(%)
Reliance 0.75 20
Tech Mahindra 0.9 25
GE 1.2 30
Raymonds 1.1 25
Calculate the expected return of the portfolio if risk free return is 6% and return on
market is 15%. Also calculate the proportion of investment in each stock if the total
investment amount is ₹ 1Lakh.

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1. Price at the beginning of the year: Rs.

Correlation=0.9, Variance of stock=49(%)^2, Variance of market=36(%)^2, Rf=5.5%,

Beta= Covariance/Variance of market

Covariance= Correlation*std dev of stock*std dev of market

Covariance= 0.9*7*6=37.8, Beta= 37.8/36= 1.05

Eg- Rm=12%, Beta of stock =1, Rs=?

Covariance= Correlation*std dev of stock*std dev of market=307.2

Alpha = Expected Return - CAPM Return

Stock Expected Beta CAPM Return

Infosys 24% 0.7 7+(15-7)*0.7=12.6%

HUL 19% 0.5 11%

Reliance 11% 1.2 16.6%

SBI 15% 1.2 16.6%

10. Consider the following information:

Is the stock underpriced or overpriced?

Covariance= Correlation*std dev of stock*std dev of market

Std dev of market=24.06%, std dev of stock= 29.94%

c) Determine the required return on the security AB according to the CAPM.

12. Amita has the following stocks in her portfolio:

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Covariance= Correlationstd dev of stockstd dev of market

Covariance= 0.976=37.8, Beta= 37.8/36= 1.05

Covariance= Correlationstd dev of stockstd dev of market=307.2

Covariance= Correlationstd dev of stockstd dev of market