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Harshit · Accepted Answer

ANSWER TO QUESTION 7
(a) Beta = 
(Return of stock in Boom - Return of Stock in Bust) / (Return of market in Boom - Return of market in Bust)
Beta of A = (33 – (-7)) / (25 – (-5))
= 40 / 30
A = 1.33	
Beta of D = (17 – (-3)) / (25 – (-5))
= 20 / 30
D = 0.67
(b) As both the scenarios are equally likely, the expected return = Average of the returns in each scenario.
Expected return of:
Market = (-5% + 25%) / 2 = 10%
Stock A = (-7% + 33%) / 2 = 15%
Stock D = (-3% + 17%) / 2 = 7%
(c) R = Rf + Beta x (Rm - Rf)
Stock A = 3% + 1.33 x (10% - 3%) = 12.31%
Stock D = 3% + 0.67 x (10% - 3%) = 7.69%
(d) Stock A is a better buy as the expected rate of return on the stock is higher than the required rate of return.

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