Question

A.

Here are data on two companies. The T-bill rate is 6.0% and the market risk premium is 7.7%.

Company	$1 Discount Store	Everything $5
Forecast return	15%	14%
Standard deviation of returns	18%	20%
Beta	1.7	1

What would be the fair return for each company, according to the capital asset pricing model (CAPM)? (Round your answers to 2 decimal places.)

Company	Expected Return
$1 Discount Store	%
Everything $5	%

B.

Consider the following information:

Portfolio	Expected Return		Standard Deviation
Risk-free	7.0	%	0	%
Market	13.4		37
A	12.0		26

Calculate the Sharpe ratios for the market portfolio and portfolio A. (Round your answers to 2 decimal places.)

	Sharpe Ratio
Market portfolio
Portfolio A

Answer 1

Part A

This question requires application of CAPM model, according to which

Expected return on a stock = Risk free rate + Beta * Market Risk premium

Hence, for $1 Discount, expected return on stock = 6% + (1.7 * 7.7%) = 19.09%

for Everything $5, expected return on stock = 6% + (1.0 * 7.7%) = 13.70%

Part B

Sharpe's Ratio is mathematically represented as:

So, Sharpe's ratio for market portfolio = (13.4% - 7%)/37% = 0.17

Sharpe's ratio for Portfolio A = (12.0% - 7%)/26% = 0.19