FIN 105 C 

170790 
CHAPTER 8 
(8-7 to 8-10, 8-13 to 8-17, 8-21) 
 
8-7 PORTFOLIO REQUIRED RETURN 
1. Portfolio beta 
bp = (3/10)(1.6) + (2/10)(0.9) + (5/10)(− 0.7)  
bp = 0.31  
2. Required rate of return 
rp = rRF + (rM − rRF )b  
rp = 4% + (12% − 4%)0.31  
rp = 0.0648 or 6.48%  
 
8-8 BETA COEFFICIENT 
At equilibrium, rjˆ = rj = 12.5% 
 
Since rj = rRF + (rM − rRF )b,  
12.5% = 4.5% + (10.5% − 4.5%)b  
b = 1.33  
 
8-9 REQUIRED RATE OF RETURN 
1. SML equation 
ri = 6% + (14% − 6%)bi  
J-Axis Co: rJ = 6% + (14% − 6%)1.2 = 15.6%  
YSL Co: rY = 6% + (14% − 6%)0.7 = 11.6%  
 
J-Axis Co. exceeds YSL Co. by 4% 
 
8-10 CAPM AND REQUIRED RETURN 
1. Market risk premium 
Since an index fund has a beta of 1.0 and RP M = rM − rRF , 
r = rRF + (RP M )b  
12% = 5% + (RP M )1.0  
RP M = 7%  
2. Bradford Manufacturing Company 
rB = 5% + 7%(1.45)  
rB = 15.15%  
3. Farley Industries 
rF = 5% + 7%(0.85)  
rF = 10.95%  
Bradford’s required return exceeds Farley’s by 4.2% 
 
 
8-13 CAPM, PORTFOLIO RISK, AND RETURN 
a. Market risk premium rM − rRF  
 Using Stock X, 
9% = 5.5% + ( rM − rRF ).8 
(rM − rRF ) = 4.375% 
b. Beta of Fund Q 
bQ = 0.8(1/3) + 1.2(1/3) + 1.6(1/3)  
bQ = 1.2  
c. Required return of Fund Q 
rQ = 5.5% + 4.375%(1.2)  
rQ = 10.75%  
 
8-14 PORTFOLIO BETA 
Since there are 20 stocks, each has a weight of 5% 
Old portfolio beta = 1.12 = (∑ bi)(0.05) ; ∑ bi = 22.4  
New portfolio beta = (22.4 - 1.0 + 1.75)(0.05) = 1.1575 ~ 1.16 
 
 
8-15 CAPM AND REQUIRED RETURN 
1. Beta (no changes) 
bAM = 1.4 , bP M = 0.7  
2. rM : 12% (falls to 12% from 16%), rRF : 7%-2% = 5% (falls 2% from 7% to 5%) 
3. SML Equation: ri = 5% + (12% − 5%)bi  
4. AM Inc: ri = 5% + (12% − 5%)1.4 = 14.8%  
5. PM Inc: ri = 5% + (12% − 5%)0.7 = 9.9%  
 
The difference between AM Inc and PM Inc is 4.9% 
 
 
8-16 CAPM AND PORTFOLIO RETURN 
1. Market risk premium 
0.23 = 0.0525 + ( rM − rRF )1.25  
(rM − rRF ) = 0.054  
2. New portfolio beta 
(500,000/5,500,000)(0.75)+(5,000,000/5,500,000)(1.25) = 1.2045 
3. Required return on new portfolio 
5.25% + (5.4%)(1.2045) = 11.75% 
 
8-17 PORTFOLIO BETA 
1. Required beta to have an expected return of 16% 
16% = 4% + (7%)b  
b = 1.7143 
2. Required beta for the additional investment 
1.7143 = (10, 000, 000)(1.3)/15, 000, 000 + (5, 000, 000)(x)/15, 000, 000  
x = 2.5429 ~ 2.5 
 
The average beta of the new stocks should be 2.5   
 
8-21 SECURITY MARKET LINE 
a. Equation for the security market line (SML) 
1. Expected market return 
ˆr
M = 0.1(−28%) + 0.2(0%)+ 0.4(12%) + 0.2(30%) + 0.1(50%) = 13%  
2. SML equation: ri = rRF + (rM − rRF )bi  
ri = 6% + (13% − 6%)bi  
 
b. Required rate of return 
1. Weights of each stock 
A = 160/500 = 0.032 
B = 120/500 = 0.24 
C = 80/500 = 0.16 
D = 80/500 = 0.16 
E = 60/500 = 0.12 
2. Beta 
bF = 0.32(0.5) + 0.24(1.2) + 0.16(1.8) + 0.16(1..0) + 0.12(1.6)  
bF = 1.088  
3. Required rate of return 
ri = 6% + (13% − 6%)1.088  
ri = 13.616%  
 
c. Required/expected rate of return 
ˆr = 6% + (7%)1.5 = 16.5%  
N
 
Since the expected return of the stock is 15%, lower than the required rate of return of 16.5%, Kish shouldn’t 
invest in the stock. The expected rate of return should be 16.5% for Kish to be indifferent to purchasing the 
stock