Assume an economy in which there are three securities: Stock A with rA = 10% and σA = 10%; Stock B with rB = 15% and σB = 20%; and a riskless asset with rRF = 7%. Stocks A and B are uncorrelated (rAB = 0). Which of the following statements is most CORRECT? 1. b. The expected return on the investor’s portfolio will probably have an expected return that is somewhat below 10% and a standard deviation (SD) of approximately 10%. 2. d. The investor’s risk/return indifference curve will be tangent to the CML at a point where the expected return is in the range of 7% to 10%.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Assume an economy in which there are three securities: Stock A with rA = 10% and σA = 10%; Stock B with rB = 15% and σB = 20%; and a riskless asset with rRF = 7%. Stocks A and B are uncorrelated (rAB = 0). Which of the following statements is most CORRECT?
| 1. |
b. The expected return on the investor’s portfolio will probably have an expected return that is somewhat below 10% and a standard deviation (SD) of approximately 10%. |
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| 2. |
d. The investor’s risk/return indifference curve will be tangent to the CML at a point where the expected return is in the range of 7% to 10%. |
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| 3. |
e. Since the two stocks have a zero correlation coefficient, the investor can form a riskless portfolio whose expected return is in the range of 10% to 15%.
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| 4. |
a. The expected return on the investor’s portfolio will probably have an expected return that is somewhat above 15% and a standard deviation (SD) of approximately 20%. |
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| 5. |
. The expected return on the investor’s portfolio will probably have an expected return that is somewhat below 15% and a standard deviation (SD) that is between 10% and 20%. |
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