Question

Consider the following information: Portfolio Expected Return Beta Risk-free 12 % 0 Market 13.8 1.0 A...

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:

Homework Answers

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

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