If the simple CAPM is valid and all portfolios are priced correctly, which of the situations below is possible? Consider each situation independently, and assume the risk-free rate is 5%. |
A)
Portfolio | Expected Return |
Beta | ||||
A | 11 | % | 1.1 | |||
Market | 11 | % | 1.0 | |||
B)
Portfolio | Expected Return |
Standard Deviation |
||||
A | 14 | % | 11 | % | ||
Market | 9 | % | 19 | % | ||
C)
Portfolio | Expected Return |
Beta | ||||
A | 14 | % | 1.1 | |||
Market | 9 | % | 1.0 | |||
D)
Portfolio | Expected Return |
Beta | ||||
A | 17.6 | % | 2.1 | |||
Market | 11 | % | 1.0 | |||
Option D
Option A
Option C
Option B
Hi
lets start option by option.
As per CAPM,
security return = risk free rate + beta*(market return - risk free rate)
option A)
Security A return = 5 + 1.1*(11-5)
=5 + 1.1*6 = 11.6 %
hence option A is wrong
Option B is anyways wrong (because if standard deviation is higher than return should be higher)
Option C ) Stock A return = 5+ 1.1*(14-9)
=5+ 1.1*5 = 5 +5.5 = 10.5%
hence option C is wrong
option D ) Stock A return = 5 + 2.1*(11-5)
=5+ 2.1*6
=5 + 12.6 = 17.6%
Hence option D is correct here.
Thanks
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