Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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Assume that using the Security Market Line (SML) the required
Expert Solution
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Step 1
Capital Asset Pricing Model (CAPM):
CAPM is the method of calculating the expected return on investment. The formula to calculate the expected return using the CAPM model is:
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Step 2
The required rate of return (RA) on stock A 1/2 return on stock B. The risk-free rate is 1/4 return on stock A. The market portfolio is RM.
Compute the beta of A (bA), using the equation as shown below:
Rearrange the above-mentioned equation to determine the beta of A as follows:
Hence, the beta of A (bA) is computed above.
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Step 3
Compute the beta of B (bB), using the equation as shown below:
Rearrange the above-mentioned equation to determine the beta of B as follows:
Hence, the beta of B (bB) is computed above.
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- The market portfolio (M) has the expected rate of return E(rM) = 0.12. Security A is traded in the market. We know that E(rA) = 0.17 and βA = 1.5. (1) What is the rate of return of the risk-free asset (rf)? (2) Security B is also traded in the market. βB = 0.8. Then what is “fair” expected rate of return of security B according to the CAPM? (3) Security C is a third security traded in the market. βC = 0.6, and from the market price, investors calculate E(rC) = 0.1. Is C overpriced or underpriced? What is αC?arrow_forwardequals the slope of the security market line: one. beta. the market risk premium. the expected return on the market portfolio.arrow_forwardIf the market portfolio has a required return of 0.12 and a standard deviation of 0.40, and the risk-free rate is 0.04, what is the slope of the security market line?arrow_forward
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- Helparrow_forwardFind the tangency portfolio mathematically (or mean-variance efficient portfolio). Follow the next steps): (look picture)arrow_forwardYou are given the following information concerning three portfolios, the market portfolio, and the risk- free asset: Portfolio X Y Z Market Risk-free Rp 14.5% R-squared 13.5 9.1 10.7 5.4 op 36% 31 21 26 0 6p 1.60 1.30 .80 1.00 0 Assume that the correlation of returns on Portfolio Y to returns on the market is 72. What percentage of Portfolio Y's return is driven by the market? (Enter your answer as a decimal not a percentage. Round your answer to 4 decimal places.)arrow_forward
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