Corporate Finance
12th Edition
ISBN: 9781259918940
Author: Ross, Stephen A.
Publisher: Mcgraw-hill Education,
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Chapter 12, Problem 9QAP
APT Assume that the following market model adequately describes the return generating behavior of risky assets:
Here:
Ru = The return on the ith asset at Time t.
RMt = The return on a portfolio containing all risky assets in some proportion at Tuner.
RMr and ∊u are statistically independent.
Short selling (i.e., negative positions) is allowed in the market. You are given the following information:
| Asset | β1 | E(R1) | Var(∊1) |
| A | .7 | 8.41% | 12.06 |
| B | 1.2 | 13.95 | .0100 |
| c | 1.5 | .0144 | .0225 |
The variance of the market is .0121, and there are no transaction costs.
- a. Calculate the standard deviation of
returns for each asset. - b. Calculate the variance of return of three portfolios containing an infinite number of asset types A, B, or C, respectively.
- c. Assume the risk-free rate is 3.3 percent and the expected return on the market is 10.6 percent. Which asset will not be held by rational investors?
- d. What equilibrium state will emerge such that no arbitrage opportunities exist? Why?
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Students have asked these similar questions
What does Jensen's alpha measure?
a.
An investor's reward in proportion to their assumption of systematic risk
b.
The abnormal return of an asset, defined as the degree to which its actual return exceeds that predicted by the capital asset pricing model
c.
The degree to which diversifiable risk is eliminated
d.
How much reward an investor is getting for each unit of risk assumed
In an efficient market when asset expected returns are plotted against asset betas, then all assets would be on the security market line
A. Because all assets have the same beta
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E. Because all assets have the same average amount of systematic risk
We believe that the single factor model can predict any individual asset’s realized rate of return well. Both Portfolio A and Portfolio B are well-diversified: ri = E(ri) + βiF + Ei, where E(ei) = 0 and Cov(F, i) = 0
A
B
β
1.2
0.8
E(r)
0.1
0.08
(1) What is the rate of return of the risk-free asset?
(2) What is the expected rate of return of the well-diversified portfolio C with βC = 1.6, which also exists in the market?
(3) A fund constructs a well-diversified portfolio D. Studies show that βD = 0.6. The expected rate of return of D is 0.06. Is there an arbitrage opportunity? If so, construct a trading strategy to earn profits with no risk. If not, why?
Chapter 12 Solutions
Corporate Finance
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