Question

# If the simple CAPM is valid and all portfolios are priced correctly, which of the situations...

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 14 % 1.4 Market 14 % 1.0

B)

 Portfolio Expected Return Standard Deviation A 17 % 14 % Market 12 % 22 %

C)

 Portfolio Expected Return Beta A 17 % 1.4 Market 12 % 1.0

D)

 Portfolio Expected Return Beta A 21.2 % 1.8 Market 14 % 1.0

Multiple Choice

• Option B

• Option A

• Option D

• Option C

A) Expected return of portfiolio A is 14% , same as market portfolio, which is not possible since it has higher beta, so according to CAPM equation it will have return greater than 14%

B)This is not possible as the portfolio will not lie on the efficient frontier but outside it

C)According to the CAPM equation,

Expected return = Risk free rate + Beta of stock * Market risk premium

= 5 + 1.4 * ( 12 - 5)

= 5 + 9.8 = 14.8

So 17% return not possible

D)According to the CAPM equation,

Expected return = Risk free rate + Beta of stock * Market risk premium

= 5 + 1.8 * ( 14 - 5)

= 5 + 16.2 =21.2

Which is the same as expected return

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