Question 1: Suppose the market portfolio has an expected return of 10% and a volatility of 20%, while Microsoft's stock has a volatility of 30%.
a. Given its higher volatility, should we expect Microsoft to have an equity cost of capital that is higher than 10%?
b. What would have to be true for Microsoft's equity cost of capital to be equal to 10%?
Question 2: Suppose all possible investment opportunities in the world are limited to the five stocks listed in the table below. What doe the market portfolio consist of (what are the portfolio weights)?
Stock Price/Share (s) Number of Shares Outstanding (millions)
A 10 10
B 20 12
C 8 3
D 50 1
E 45 20
Question 3: Using the data in Problem above, suppose you are holding a market portfolio, and have invested $12,000 in Stock C.
a. How much have you invested in Stock A?
b. How many shares of Stock B do you hold?
c. If the price of Stock C suddenly drops to $4 per share, what trades would you need to make to maintain a market portfolio?