Question

Consider the following information:

Portfolio	Expected Return		Beta
Risk-free	12	%	0
Market	13.8		1.0
A	11.8		0.9

a. Calculate the expected return of portfolio A with a beta of 0.9. (Round your answer to 2 decimal places.)

Expected return             %

b. What is the alpha of portfolio A. (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

Alpha             %

c. If the simple CAPM is valid, is the above situation possible?

	Yes
	No

Bonus:

A share of stock is now selling for $125. It will pay a dividend of $8 per share at the end of the year. Its beta is 1. What do investors expect the stock to sell for at the end of the year? Assume the risk-free rate is 7% and the expected rate of return on the market is 19%. (Round your answer to 2 decimal places.)

Expected selling price:

Answer 1

a)According to CAPM
Return on portfolio A= Risk free rate + beta * ( Market risk - Risk free rate) = 12% + 0.9 * ( 13.8% - 12%) = 13.62%
b) Alpha = Expected return - Return on portfolio using CAPM model = 11.8% - 13.62% = - 1.82%

c) No simple Capm is not valid as aplha is not included here.

d)Cost of Equity as per CAPM model = Risk free rate + beta * ( Market risk - Risk free rate) =
7% + 1 * ( 19 % - 7%) = 19%
So return = (Price after 1 year + dividend - Price at present time)/Price at present time
19% = (P₁ + 8 - 125)/ 125
Selling price P₁ = 125 * 19% +125 -8 = 140.75


Best of Luck. God Bless