Question

Excel Online Structured Activity: CAPM, portfolio risk, and return

Consider the following information for three stocks, Stocks A, B, and C. The returns on the three stocks are positively correlated, but they are not perfectly correlated. (That is, each of the correlation coefficients is between 0 and 1.)

Stock	Expected Return		Standard Deviation		Beta
A	8.70	%	16	%	0.8
B	10.30		16		1.2
C	11.50		16		1.5

Fund P has one-third of its funds invested in each of the three stocks. The risk-free rate is 5.5%, and the market is in equilibrium. (That is, required returns equal expected returns.) The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.

Open spreadsheet

CAPM, portfolio risk, and return
Risk-Free Rate, rRF	5.50%
	Stock A		Formula		Stock B		Formula		Stock C		Formula
Expected Return	8.70%				10.30%				11.50%
Standard Deviation	16.00%				16.00%				16.00%
Beta	0.80				1.20				1.50
Market Risk Premium, RPM			#N/A				#N/A				#N/A
% Stock in Fund P	0.333333				0.333333				0.333333
Beta of Fund P			#N/A
Required Return of Fund P			#N/A
Expected Return of Fund P			#N/A

1. What is the market risk premium (r_M - r_RF)? Round your answer to two decimal places.

   %

2. What is the beta of Fund P? Do not round intermediate calculations. Round your answer to two decimal places.

3. What is the required return of Fund P? Do not round intermediate calculations. Round your answer to two decimal places.

   %

4. Would you expect the standard deviation of Fund P to be less than 16%, equal to 16%, or greater than 16%?

   1. less than 16%
   2. greater than 16%
   3. equal to 16 %

Answer 1

a.using stock A data

As per CAPM

expected return = risk-free rate + beta * (Market risk premium)

8.7 = 5.5 + 0.8 * (Market risk premium%)

Market risk premium% = 4

b

beta of fund = weight of stock A*beta of stock A + weight of stock B*beta of stock B + weight of stock A*beta of stock C

=1/3*0.8+1/3*1.2+1/3*1.5 = 1.17

c

return of fund = weight of stock A*return of stock A + weight of stock B*return of stock B + weight of stock A*return of stock C

=1/3*8.7+1/3*10.3+1/3*11.5 = 10.17

d

less than 16% because all std devs are 16% and correlations are less than 1

if they were 1 it would be 16%

and more than 1 then greater than 16%