Question

Problem1

Are statements below true or false? Explain your answer.

a) (0.5 point) Assume that CAPM holds. Given that stocks A and B, which are traded in the same market, have the same expected return, their betas must be the same.

b) (0.5 point) Stocks A and B, which are traded in the same market, have the same beta. Given that Correlation(A,Market)>Correlation(B,Market), it must be the case that Standard deviation(A)<Standard deviation(B).

c) (0.5 point) Assume that CAPM holds. In January 2015 stock A had some expected return. In February 2015 risk-free rate increased compared to January 2015, but the expected market return and stock A beta stayed the same. It must be the case that the expected return on stock A increased in February 2015 compared to its expected return in January 2015.

d) (0.5 point) If the stock market consists of only 1 stock, that stock must have a beta of 1. Problem 2: Expected Return (2 points)

Assume that CAPM holds. Stock A has beta of 0.4. The expected market return is 10%. The risk-free rate is 1.5%. What is the expected return on stock A?

Problem 3: Risk-free Rate (2 points)
Assume that CAPM holds. Stock A has a beta of 1.8 and expected return of 21.2%. The

expected market return is 12%. What is the risk-free rate?

Answer 1

As per rules I will answer the first 4 sub parts of this question.

1:True

The CAPM equation is ER= Rf+ Beta*risk premium. Since the Rf and risk premium of the two stocks are same, the betas are also the same for the two stocks.

2:False

Beta is same only if standard deviations are same.

3: True

If Rf increases, the expected return on stock will increase if expected market return and beta is the same.

4: True

If the stock market has only 1 stock, its beta is determined by that stock alone. This means that the beta of the stock is equal to the market performance= 1.