A.
To determine: The expected return and the alpha for each stock.
Introduction: The
A.
Answer to Problem 12CP
For each stock X, expected return is 12.2% and the alpha is 1.8%.
For each stock Y, expected return is 18.5% and the alpha is -1.5%.
Explanation of Solution
Given Information:
The capital asset pricing model describes the expected return on beta based security. This model is used for determining the expected
With substituting the value of beta 0.8, expected rate of return on market
For stock X, the expected return is
With substituting the value of beta
For stock Y, the expected return is
Calculation of alpha for stock X,
So, the alpha for stock X is
Calculation of alpha for stock Y,
So, the alpha for stock Y is
B.
To determine: The most appropriate stock for the investor
Introduction: The Capital Asset Pricing Model explains the relationship among the systematic risk of an asset and the return that are expected.
B.
Answer to Problem 12CP
Stock Y should be chosen
Explanation of Solution
Given Information:
Forecast returns, standard deviations and the beta values are given.
The capital asset pricing model describes the expected return on beta based security. This model is used for determining the expected return on asset, which is based on systematic risk. An investor should invest in single stock, when stock having high expected
Here, Risk premium is
Standard deviation is
Expected rate of return is
Risk free return is
So, the Sharpe ratio is 25% for stock X
So, the Sharpe ratio is
Determination of Sharpe ratio of market index,
Sharpe ratio of market index is
As the Sharpe ratio and the expected return of Sock Y are higher, the risk becomes lesser. So, stock Y is chosen by the investor.
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Chapter 9 Solutions
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- Karen Kay, a portfolio manager at Collins Asset Management, is using the capital asset pricing model for making recommendations to her clients. Her research department has developed the information shown in the following exhibit. Forecast Returns, Standard Deviations, and Betas Stock X Stock Y Market index Risk-free rate Forecast Return 14.0% 17.0% 14.0% 5.0% Standard Deviation 36% 25% 15% Beta 0.8 1.5 1.0 a. Calculate expected return and alpha for each stock. b. Identify and justify which stock would be more appropriate for an investor who wants to i. Add this stock to a well-diversified equity portfolio. ii. Hold this stock as a single-stock portfolio.arrow_forwardPlease see the attached diagram image. Please show how to solve this problem and please show all steps and formulas in Excel. Based on the Capital Asset Pricing Model (CAPM) and the diagram below, what is the return of the stock if its beta is 1.2 or 0.8?arrow_forwardas the chief investment officer for a money management firm specializing in taxable individual investors, you are trying to establish a strategic asset allocation for two different clients. You have established that Ms. A has a risk-tolerance factor of 9, while Mr. B has a risk-tolerance factor of 27. The characteristics for four model portfolios follow: ASSET MIX Portfolio Stock bond ER σ2 1 9% 91% 8% 5% 2 21 79 9 9 3 69 31 10 14 4 84 16 11 24 Calculate the expected utility of each prospective portfolio for each of the two clients. Do not round intermediate calculations. Round your answers to two decimal places. Portfolio Ms. A Mr. B 1 2 3 4arrow_forward
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