MGT 201 GDB

MGT 201 GDB

Given a risk-free rate of 8 percent and a market risk premium of 9.5 percent, based on the betas given in the following table:

Security	Beta
A	0.95
B	1.25

1.     Calculate required rate of return of each stock?

2.     If Ahmed is a risk lover investor, he will prefer to invest in which stock?

3.     As against it, Shahzad is a risk averse investor; he will prefer to invest in which stock?

SOLUTION:

REF:

FROM PAGE NO.156 OFFINANCIAL MANAGEMENT BY EUGENE F.BRIGHAM

http://www.rhsmith.umd.edu/faculty/gphillips/courses/Bmgt640/Sml.pdf 

 and also this link at page no 18.FOR INDIVIDUAL RISK

OR ALSO

http://www.valuebasedmanagement.net/methods_capm.html   

The relation ship between the required return and risk is called the Security market line.

Sml equation.

Required rate of return on stock= risk-free rate +(markete risk premium)(stock s beta)

            OR

                        r_{i         =} r _RF+(r_m-r_RF)(b_i)     where (r_m-r_RF)=RPm

r_i= required rate of return

r_RF= risk-free rate

r_{m=EXPECTED RATE OF RETURN}

_RPm= market risk premium

FOR STOCK A PUTTING VALUES IN EQUATION

r_{i       =} 8%+9.5% (0.95)

ri    =17.025%

and for stock b

Required rate of return on stock= risk-free rate +(markete risk premium)(stock s beta)

Putting the values in equation

r_{i       =} 8%+9.5% (1.25)

                        ri    =19.875%

2.     If Ahmed is a risk lover investor, he will prefer to invest in which stock?

Note. Stock have a large beta ,hence be risky.

Because MR. AHMED is a risk lover person so he will prefer to invest in stock which have a great return with high risk so he will prefer to invest in stock B.

3.     As against it, Shahzad is a risk averse investor; he will prefer to invest in which stock?

A RISK AVERSE PERSON WILL INVEST IN STOCK WHICH HAS A LESS RISKY.SO MR.SHAHZAD WILL INVEST IN STOCK A.BECAUSE ITS BETA IS LOW.

Note. Stock have a large beta ,hence be risky.