Question

1. Consider the CAPM model. The return on stock X is 15%. The market index has a risk premium of 12% and a standard deviation of 14%. The T-bill rate is 2%. The covariance between X and the market index is ____.

   	A.	0.0255
   	B.	0.0212
   	C.	0.1735
   	D.	0.1820

Answer 1

We know that capm equation

Er = Rf + B( Rm - Rf)

Where,

Er is expected return

Rf is risk free return

B is beta

Rm is market return

Rm - Rf is market risk premium

So, we will calculate beta

15% = 2% + B (12%)

15% - 2% = 12% B

13% / 12% = B

Beta = 1.0833

Now,

Beta = Covariance ( x,m) / Variance (m)

Where m is market. D x is stock

Variance = *standard deviation) ^2

= 14%^2

= 0.0196

So,

1.08333 = Covariance / 0.0196

Covariance = 0.0196 × 1.0833

= 0.0212

Option B is the correct answer