Question

**CAPM, PORTFOLIO RISK, AND RETURN**

Consider the following information for 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 | 10.10% | 16% | 0.9 | ||

B | 11.01 | 16 | 1.1 | ||

C | 13.28 | 16 | 1.6 |

Fund P has one-third of its funds invested in each of the three stocks. The risk-free rate is 6%, and the market is in equilibrium. (That is, required returns equal expected returns.)

- What is the market risk premium (r
_{M}- r_{RF})? Round your answer to two decimal places.

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

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

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

- Less than 16%
- Greater than 16%
- Equal to 16%

Answer #1

a

Using stock A data

As per CAPM |

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

10.1 = 6 + 0.9 * (Market risk premium%) |

Market risk premium% = 4.56 |

b

Weight of A = 0.3333 |

Weight of B = 0.3333 |

Weight of C = 0.3333 |

Beta of Portfolio = Weight of A*Beta of A+Weight of B*Beta of B+Weight of C*Beta of C |

Beta of Portfolio = 0.9*0.3333+1.1*0.3333+1.6*0.3333 |

Beta of Portfolio = 1.20 |

c

Weight of A = 0.3333 |

Weight of B = 0.3333 |

Weight of C = 0.3333 |

Expected return of Portfolio = Weight of A*Expected return of A+Weight of B*Expected return of B+Weight of C*Expected return of C |

Expected return of Portfolio = 10.1*0.3333+11.01*0.3333+13.28*0.3333 |

Expected return of Portfolio = 11.46 |

d

Less than 16% as std dev of all stocks are 16% and they are not perfectly correlated

CAPM, PORTFOLIO RISK, AND RETURN
Consider the following information for 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.)
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Expected Return
Standard Deviation
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A
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Standard
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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
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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
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16
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Fund P has one-third of its funds invested in each of the three
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onsider the following information for 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
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has one-third of its funds invested in each of the three stocks.
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