Chp 7.1 - 7.3

Beta is a measure of __________.

relative systematic risk

You invest $850 in security A with a beta of 1.6 and $650 in security B with a beta of 0.8. The beta of this portfolio is __________. Portfolio 1.5k Security A 0.85k Beta 1.6 Security B 0.65k Beta 0.8 Portfolio Beta ?

(0.85/1.5)*1.6 = 0.9067 (0.65/1.5)*0.8 = 0.3467

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%.

(Exp Return A - Risk Free/ A Beta) = (Exp Return M - Risk Free/ M Beta) (23.0% − 5)/2.0 = (14% − 5)/1.0 > two portfolios with different betas cannot have the same expected return. > under CAPM market portfolio must yield highest CAL.C) > portfolio A and the market have different excess returns per unit of risk.

In a simple CAPM world which of the following statements is (are) correct? 1. All investors will choose to hold the market portfolio, which includes all risky assets in the world. 2. Investors' complete portfolio will vary depending on their risk aversion. 3. The return per unit of risk will be identical for all individual assets. 4. The market portfolio will be on the efficient frontier, and it will be the optimal risky portfolio.

1, 2, 3, and 4

Which of the following are assumptions of the simple CAPM model? 1. Individual trades of investors do not affect a stock's price. 2. All investors plan for one identical holding period. 3. All investors analyze securities in the same way and share the same economic view of the world. 4. All investors have the same level of risk aversion.

1, 2, and 3 only

If the beta of the market index is 1 and the standard deviation of the market index increases from 12% to 18%, what is the new beta of the market index?

1.0 Market beta always equals 1 regardless of market volatility.

What is the expected return on the market?

10%

Kaskin, Incorporated, stock has a beta of 1.2 and Quinn, Incorporated, stock has a beta of 0.6. Which of the following statements is most accurate? > The equilibrium expected rate of return is higher for Kaskin than for Quinn. Not attempted > The stock of Kaskin has more total risk than Quinn. Not attempted > The stock of Quinn has more systematic risk than that of Kaskin.

> Statement "The equilibrium expected rate of return is higher for Kaskin than for Quinn." is most accurate. > The flaw in statement "The stock of Kaskin has more total risk than Quinn." is that beta represents only the systematic risk. If the firm-specific risk is low enough, The stock of Quinn has more systematic risk than that of Kaskin. > Statement "The stock of Quinn has more systematic risk than that of Kaskin." is incorrect. Lower beta means the stock carries less systematic risk.

What is the expected return for a portfolio with a beta of 0.5?

CAPM : E(rP) = rf + βp × [E(rM) − rf] E(rP) = 0.05 + 0.5 × [0.10 − 0.05] = 0.075 = 7.50%

What is the beta for a portfolio with an expected return of 12.5%?

CAPM : E(rP) = rf + βp × [E(rM)−rf] 0.125 = 0.05 + βp × [0.10 − 0.05] Solve for βP βp = 1.5

A stock has an expected return of 11%. What is its beta? Assume the risk-free rate is 4% and the expected rate of return on the market is 12%

E(r) = r(f) + Beta (ErM - r(f)) 11% = 4% + Beta (12% − 4%) 7% =8%Beta 0.88 = Beta

What must be the beta of a portfolio with E(rP) = 11.80%, rf = 6% E(rM) = 10%? (Round your answer to 2 decimal places.)

E(r) = r(f) + Beta (ErM - r(f)) 11.80% = 6% + Beta (10% − 6%) 5.8% = 4%Beta 1.45% = Beta

Consider the CAPM. The expected return on the market is 14%. The expected return on a stock with a beta of 1.2 is 15%. What is the risk-free rate?

E(r) = r(f) + Beta (ErM - r(f)) 15% = r(f) + 1.2(14% − r(f) 9% = r(f)

What must be the beta of a portfolio with E(rP) = 20%, if rf = 5% and E(rM) = 15%?

E(r) = r(f) + Beta (ErM - r(f)) 20% = 5% + Beta(15% − 5%) 15% = 10%Beta 1.5 = Beta

Consider the CAPM. The risk-free rate is 8%, and the expected return on the market is 19%. What is the expected return on a stock with a beta of 1.8?

E(r) = r(f) + Beta (ErM - r(f)) E(r) = 8% + 1.8 [ 19% − 8%] = 27.8%

What is the expected rate of return for a stock that has a beta of 1 if the expected return on the market is 15%?

E(r) = r(f) + Beta (ErM - r(f)) E(r) = r(f) + 1 (15% - r(f)) E(r) = r(f) + (15% - r(f)) E(r) = 15%

According to the CAPM, what is the market risk premium given an expected return on a security of 18.7%, a stock beta of 1.3, and a risk-free interest rate of 7%?

E(r) = r(f) + Beta (MRP) 18.7% = 7% + 1.3 × (market risk premium); MRP = 9.00%

What is the expected rate of return for a stock that has a beta of 1 if the expected return on the market is 14%?

Expected Return = risk free rate + Beta( Expected market return - risk free rate) E(r) = r(f) + Beta (ErM - r(f)) E(r) = r(f) + ErM - r(f) E(r) = ErM

You have a $42,000 portfolio consisting of Intel, GE, and Con Edison. You put $22,400 in Intel, $8,800 in GE, and the rest in Con Edison. Intel, GE, and Con Edison have betas of 1.3, 1, and 0.8, respectively. What is your portfolio beta? Portfolio 42k Beta ? Intel [ 22.4k ] Beta 1.3 GE [ 8.8k ] Beta 1 CEI [ 10.8k ] Beta 0.8

Intel (22.4/42)*1.3 + GE (8.8/42)*1.0 + CEI (10.8/42)*0.8 + 0.6933 + 0.2095 + 0.2057 portfolio beta = 1.1085

If the simple CAPM is valid, is the following situation possible? Risk-free: Expected Return 10% Standard Deviation 0% Market Expected Return 18% Standard Deviation 24% A Expected Return 20% Standard Deviation 22%

Not possible. The market always wins Portfolio A clearly dominates the market portfolio. It has a lower standard deviation with a higher expected return.

If the simple CAPM is valid, is the following situation possible? Risk-free: Expected Return 10% Standard Deviation 0% Market Expected Return 18% Standard Deviation 24% A Expected Return 16% Standard Deviation 22%

Possible. The market always wins Portfolio A's ratio of risk premium to standard deviation is less attractive than the market's. This situation is consistent with the CAPM. The market portfolio should provide the highest reward-to-variability ratio.

Here are data on two companies. The T-bill rate is 4.8% and the market risk premium is 5.9%. $1 Discount Store 1Forecast return = 12% Standard deviation of returns = 12% Beta = 1.6 Everything $5 1Forecast return = 11% Standard deviation of returns = 14% Beta = 1.0 What would be the expected rate of return for each company, according to the capital asset pricing model (CAPM)?

Risk Free Rate + Beta(Market Risk Premium) $1 Discount Store 4.8% + 1.6(5.9%) = 4.8% + 9.944% = = 14.24% Everything $5 4.8% + 1.0(5.9%) = 10.7%

An investor should do which of the following for stocks with negative alphas?

Sell short

In a world where the CAPM holds, which one of the following is not a true statement regarding the capital market line?

The capital market line is also called the security market line.

Risk-free: Expected Return 6% Standard Deviation 0% Market Expected Return 10.8% Standard Deviation 24% A Expected Return 8.8% Standard Deviation 13% a. Calculate the Sharpe ratios for the market portfolio and portfolio A. (Round your answers to 2 decimal places.) b. If the simple CAPM is valid, is the above situation possible?

a. Sharpe Ratio (Expected Return - Risk Free Rate)/ Indiv Std Deviation Market Sharpe Ratio (8.8 - 6)/13 = 21.54 A Sharpe Ratio (10.8 - 6)/24 = 20% b. Not possible. The reward-to-variability ratio for Portfolio A is better than that of the market, which is not possible according to the CAPM, since the CAPM predicts that the market portfolio is the most efficient portfolio. These figures imply that Portfolio A provides a better risk-reward tradeoff than the market portfolio.

Suppose the yield on short-term government securities (perceived to be risk-free) is about 5%. Suppose also that the expected return required by the market for a portfolio with a beta of 1.0 is 8.0%. According to the capital asset pricing model: a. What is the expected return on the market portfolio? (Round your answer to 1 decimal place.) b. What would be the expected return on a zero-beta stock? Suppose you consider buying a share of stock at a price of $100. The stock is expected to pay a dividend of $9 next year and to sell then for $103. The stock risk has been evaluated at β = −0.5. c-1. Using the SML, calculate the fair rate of return for a stock with a β = −0.5. (Round your answer to 1 decimal place.) c-2. Calculate the expected rate of return, using the expected price and dividend for next year. (Round your answer to 2 decimal places.) c-3. Is the stock overpriced or underpriced?

a. Since the market portfolio, by definition, has a beta of 1.0, its expected rate of return is 8.0%. b. β = 0 means the stock has no systematic risk. Hence, the portfolio's expected rate of return is the risk-free rate, 5%. c-1 Fair rate of return E(r) = r(f) + Beta (ErM - r(f)) = 5% + (−0.5) × (8.0% − 5%) = 5% - 1.5% = 3.5% c-2 Expected rate of return (Sale Price + Dividend / Buy Price) - Beta [ ($103 + $9)/$100 ] − 1 = 0.1200 = 12.00% c-3. Because the expected return exceeds the fair return, the stock must be under-priced.

A stock's alpha measures the stock's __________.

abnormal return

The measure of risk used in the capital asset pricing model is __________.

beta

In a well-diversified portfolio, __________ risk is negligible.

unsystematic

According to the capital asset pricing model, fairly priced securities have __________.

zero alphas

According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio is __________.

directly related to the beta of the stock

The expected return on the market is the risk-free rate plus the __________.

equilibrium risk premium

A stock has a beta of 1.3. The systematic risk of this stock is __________ the stock market as a whole.

higher than

When all investors analyze securities in the same way and share the same economic view of the world, we say they have __________.

homogeneous expectations

In his famous critique of the CAPM, Roll argued that the CAPM __________.

is not testable because the true market portfolio can never be observed

According to the capital asset pricing model, a fairly priced security will plot __________.

on the security market line

Investors require a risk premium as compensation for bearing __________.

systematic risk

According to capital asset pricing theory, the key determinant of portfolio returns is __________.

the systematic risk of the portfolio Correct

Standard deviation of portfolio returns is a measure of __________.

total risk