Question

# 1. The Security Market Line (SML) is a graphical representation of returns associated with beta. Choose...

1. The Security Market Line (SML) is a graphical representation of returns associated with beta. Choose the correct statement regarding to the SML. If your estimated return is above the SML, the stock is overvalued. You cannot use SML to understand if the stock is overvalued or undervalued. If your estimated return is on the SML, the stock is overvalued. If your estimated return is below the SML, the stock is overvalued. None of the above are correct.

2.

What is the beta of the following portfolio?

 Stock Beta Investment A 1.2 \$50,000 B 0.7 \$80,000 C 0.5 \$30,000 D 1.4 \$40,000

Round to the second decimal place.

3.

Calculate the standard deviation of a portfolio consisting of 40 percent stock P and 60 percent stock Q.

Company Beta Expected Return Variance Correlation Coefficient
P 1.3 28% 0.30 CORRP,Q = 0.3
Q 2.6 12% 0.16

1. The correct answer is d) If your estimated return is below the SML, the stock is overvalued.

If the estimated return is below the SML, then the stock is expected to return less for a similar risk, which means that the stock is overvalued.

2. Total investment = 50,000 + 80,000 + 30,000 + 40,000 = 200,000

Portfolio Beta is the weighted average beta of the stocks

Portfolio Beta = 50,000/200,000 * 1.2 + 80,000/200,000 * 0.7 + 30,000/200,000 * 0.5 + 40,000/200,000* 1.4

Portfolio Beta = 0.935

3.

sigma1 = sqrt(0.3) = 0.5477225575

sigma2 = sqrt(0.16) = 0.4

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