Problems(20 points each) You are a portfolio manager and you use the capital ass

Question

Problems(20 points each) You are a portfolio manager and you use the capital asset pricing recommendations to your clients. The research department h information shown in the following exhibit. 1. model for making as developed the Forecast Returns, Standard Deviations, and Betas Beta 0.8 1.5 1.0 Forecast Return Standard Deviation Stock X Stock Y Market index Risk-free rate 14.0% 17.0 14.0 5.0 36% 25 15 a)Calculate expected return and b)alpha for each stock. Identify and justify which stock would be more appropriate for an investor who wants to c)Add this stock to a well-diversified equity portfolio. d)Hold this stock as a single-stock portfolio.

Explanation / Answer

a)Expected Return for X= 5+0.8(14-5)=12.2%

for Y=5+1.5(14-5)= 18.5%

b) Alpha for X= Forecast Return -Expected Return=14-12.2=1.8%

for Y=17-18.5=-1.5%

c)For well diversified portfolio unsystematic risk is negligible hence we can have stock with higher standard deviation that is stock X

d) For SIngle stock we have highest unsystematic risk and hence should have stock with lower standard deviation that is stock Y

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