Question

In CAPM how do changes in the risk free rate affect investor utility?

Answer #1

The risk free rate is the rate at which an identical market rate for the security at which the investor will not incur any financial loss. Risk free rate of interest is of great significance in CAPM since the slightest increase/ decrease can change the expected market return on the security.

Example:

CAPM= Risk free rate + Beta * Market Premium

Situation 1: Risk free rate= 5% ,Beta=0.5, Market premium= 8%

Expected return= 5%+0.5*8% = 9%

Situation 2: Lets assume the risk free rate was wrongly taken as 3%. Other values are same.

Expected return= 3% + 0.5*8%= 7%

In the above example, a change in risk free rate of return has reduced the expected return on the security. A security with lesser expecte rate of return than the risk free rate will sell for a lesser price and vice versa.

According to the CAPM, the required return of an asset is the
sum of risk-free rate of return and beta times the risk
premium.
True
False

Assume the CAPM holds. The risk-free rate is 5% and the market
portfolio expected return is 15% with a standard deviation of 20%.
An asset has an expected return of 16% and a beta of 0.8.
a) Is this asset return consistent with the CAPM? If not, what
expected return is consistent with the CAPM?
b) How could an arbitrage profit be made if this asset is
observed?
c) Would such a situation be expected to exist in the longer...

Consider an economy consisting of two stocks (X and Y) and a
risk-free asset. Investor A maximizes his utility function by
investing 10% of his wealth in the risk-free asset, 75% in X, and
15% in Y. Investor B maximizes his utility function by investing
40% of his wealth in the risk-free asset. What fraction of his
wealth does investor B invest in X?
A.
15%
B.
60%
C.
37.5%
D.
50%

How do changes in the market interest rate affect business
spending and consumer spending?

A stock has a beta of 1.8. The risk-free rate is 2%. Assume that
the CAPM holds.
A: What is the expected return for the stock if the expected
return on the market is 11%? 3+ Decimals
B: What is the expected return for the stock if the expected
market risk premium is 11%? 3+ Decimals

If the IOP Corporation follows CAPM and the market and risk-free
rate of return are 12 and 5 percent, respectively. Obtain the
firm’s beta, assuming that the cost of equity capital is 13
percent. Round your final answer to two decimal places.

An investor can choose to allocate her investment into a risky
portfolio and the risk-free rate. The risky portfolio has an
expected return of 18.3 percent and a standard deviation of 21.0
percent. The risk-free rate is 8.4 percent. The investor targets a
complete portfolio with an expected return of 14 percent. The
standard deviation of this complete portfolio is

How a risk neutral investor allocates her asset between a risk
free security and a risky asset. The risk-free return is 5% and the
return of the risky asset is 7% with a standard deviation of
4%.

Which of the following provides the best estimate of the
risk-free interest rate for the CAPM approach to estimating the
cost of retained earnings?
30-day Treasury bill
10- or 30-year Treasury bond
30-year IBM bond
90-day Treasury bill
none of the above

Suppose the risk-free rate is 3% and the average investor has a
risk-aversion coefficient of 1.4. Further, assume that the standard
deviation for the market portfolio is 14%.
1. What is the equilibrium value of the market risk premium?
2. What is the expected rate of return on the market?
3. What is the equilibrium value of the market risk premium if
the average investor had a risk aversion coefficient of 1.1 instead
of 1.4?
d. Why does the answer...

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