1) Expected Returns: Discrete Distribution
The market and Stock J have the following probability distributions:
Probability__________rM__________ ____rJ__________
0.3 15% 20%
0.4 9 5
0.3 18 12
a) Calculate the expected rates of return for the market and Stock J.
b) Calculate the standard deviations for the market and Stock J.
2) Required Rate of Return
As an equity analyst you are concerned with what will happen to the required return to Universal Toddler Industries’ stock as market conditions change. Suppose rRF= 5%, rM=12%, and bUTI-1.4
a) Under current conditions, what is rUTI, the required rate of return on UTI stock?
b) Now suppose rRF (1) increases to 6% or (2) decreases to 4%. The slope of the SML remains constant. How would this affect rM and rUTI?
c) Now assume rRF remains at 5% byt rM (1) increase to 14% or (2) falls to 11%. The slope of the SML does not remain constant. How would these changes affect rUTI?