You are given the following data: Historical Rates of Return
Year NYSE Stock X
1 (26.5%) (14.0%)
2 37.2 23.0
3 23.8 17.5
4 (7.2) 2.0
5 6.6 8.1
6 20.5 19.4
7 30.6 18.2
a. Use a spreadsheet (or a calculator with a linear regression function) to determine Stock X's beta coefficient.
b. Determine the arithmetic average rates of return for Stock X and the NYSE over the period given. Calculate the standard deviations of return for both Stock X and the NYSE.
c. Assuming (1) that the situation during years 1-7 is expected to hold true in the future (that is, r(carrot)x = r (line)x; r (carrot)m = r (line)m; and both Ox and Bx in the future will equal their past values) and (2) that Stock X is in equilibrium (that is, it plots on the Security Market Line), what is the risk-free rate
d. Plot the Security Market Line.
e. Suppose you hold a large, well-diversified portfolio and are considering adding to the portfolio either Stock X or another stock, Stock Y, that has the same beta as Stock X but a higher standard deviation of returns. Stocks X and Y have the same expected returns; that is r (carrot)x = r (carrot)y = 10.6%. Which stock should you choose?