1.Suppose Best Buy stock is trading for $40 per share for a total market cap of $16 billion, and Walt Disney has 1.8 billion shares outstanding. If you hold the market portfolio, and as part of it hold 100 shares of Best Buy, how many shares of Walt Disney do you hold?
2.Standard and Poor’s also publishes the S&P Equal Weight Index, which is an equally weighted version of the S&P 500.
a. To maintain a portfolio that tracks this index, what trades would need to be made in response to daily price changes?
b. Is this index suitable as a market proxy?
3.Suppose that in place of the S&P 500, you wanted to use a broader market portfolio of all U.S. stocks and bonds as the market proxy. Could you use the same estimate for the market risk premium when applying the CAPM? If not, how would you estimate the correct risk premium to use?
4.From the start of 1999 to the start of 2009, the S&P 500 had a negative return. Does this mean the market risk premium we should use in the CAPM is negative?
5.You need to estimate the equity cost of capital for XYZ Corp. You have the following data available regarding past returns:
a. What was XYZ’s average historical return?
b. Compute the market’s and XYZ’s excess returns for each year. Estimate XYZ’s beta.
c. Estimate XYZ’s historical alpha.
d. Suppose the current risk-free rate is 3%, and you expect the market’s return to be 8%. Use the CAPM to estimate an expected return for XYZ Corp.’s stock.
e. Would you base your estimate of XYZ’s equity cost of capital on your answer in part (a) or in part (d)? How does your answer to part (c) affect your estimate? Explain.