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
Hence answer= D)
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