i) Calculate the expected return for each stock assuming the Capital Asset Pricing Model (CAPM) is valid, and explain if they are correctly priced. Show your calculations. b) Consider the following information in Table 3 for stocks A and B.Table 3StockForecasted Return (%)Standard Deviation (%)CAPM-betaА11%25%0.7В13%20%1.4The risk-free rate of return is 5%, the expected rate of return on the market index is11%, and the standard deviation of the market index returns is 15%.

Risk free rate = 5% Expected return on market = 11% Beta of stock A = 0.7 Beta of stock B = 1.4

Answered: Calculate the expected return for each…

Calculate the expected return for each stock assuming the Capital Asset Pricing Model (CAPM) is valid, and explain if they are correctly priced. Show your calculations.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter3: Risk And Return: Part Ii

Section: Chapter Questions

Problem 1P: The standard deviation of stock returns for Stock A is 40%. The standard deviation of the market...

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Concept explainers

Portfolio Management

Portfolio management is the process by which an investor decides that how the person will invest in a variety of assets in order to get a desired return in the future. A portfolio means a pool of assets that includes securities, bonds, and other investment instruments which helps in risk minimization of the money that has been invested. In other words, it can be said that a portfolio means a combination of assets in which an investor decides to invest their money in order to get a lump sum return in the future or even a series of cash flow that the person is expecting at the end of their job life.

Question

i) Calculate the expected return for each stock assuming the Capital Asset Pricing Model (CAPM) is valid, and explain if they are correctly priced. Show your calculations.

b) Consider the following information in Table 3 for stocks A and B.
Table 3
Stock
Forecasted Return (%)
Standard Deviation (%)
CAPM-beta
А
11%
25%
0.7
В
13%
20%
1.4
The risk-free rate of return is 5%, the expected rate of return on the market index is
11%, and the standard deviation of the market index returns is 15%.

Definition Definition Model that illustrates the correlation between the expected return and risk of capital investment in stock. According to this model, the expected rate of return on equity is equal to the risk-free return added to a risk premium, which is based on the stock beta.

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