Question

Question 7

Assume that CAPM holds.
a) You believe that IBM stock will be worth $40 per share one year from now. How much
are you willing to pay for one share today if the annualized risk-free rate is 8 percent, the
expected rate of return on the market is 15 percent, the variance of market return is 9
percent and IBM’s beta is 0.83?
b) Continuing from part (a), Jon has $1000 to invest, and he borrows an additional $800 to
invest. What is his portfolio’s expected return and standard deviation of return?

This is all the information i have that is the full information. Please Answer

Answer 1

Answer (a): Share price of 1 share will be $40, so price of the share today should be

Future price/ (1+Expected rate of return)

Here Expected rate of return will be calculated as follows:

Expected Rate of Return = Risk free rate of return + Beta*(Market expected return- Risk free rate of return)

= 0.08 + 0.83*(0.15-0.08)

= 0.08+ 0.0581

= 0.1381/13.81%

So the price maximum we can pay today for the share is ($40/1.1381) which is $35.15.

Answer (b): Suppose we have borrowed $800 from market @8% p.a.

So, the total return on the portfolio after 1 year will be ($1800*13.81%) = $248.58

Which is again 13.81%

Standard Deviation of the same is root square of market variance which is square root of 9% i.e. 0.30

Therefore the standard deviation is 0.30.