EDT Excel Online Structured Adtivity: CAPM, portfolio risk, and return Consider
ID: 1170794 • Letter: E
Question
EDT Excel Online Structured Adtivity: 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 coeffidients is between 0 and 1.) Stock Expected Return 8.79 % 11.14 12.55 Standard Deviation 14% 14 14 Beta 0.7 1.2 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. a. What is the market risk premium (f - Far)? Round your answer to two decimal places. b. What is the beta of Fund P? Do not round intermediate calculations. Round your answer to two decimal places. c. What is the required return of Fund P? Do not round intermediate calculations. Round your answer to two decimal places. d, would you expect the standard deviation of Fund p to be less than 14%, equal to 14%, or greater than Back 1040 AMExplanation / Answer
Because instead of an actual spreadsheet, the image of a spreadsheet was provided with the question, I have solved the above questions manually.
a. As per CAPM, expected return=risk-free return+market risk premium*beta, so
market risk premium=(expected return-risk-free return)/beta
For A, RPM=(8.79-5.5)/0.7=4.7
For B, RPM=(11.14-5.5)/1.2=4.7
For C, RPM=(12.55-5.5)/1.5=4.7
b. Beta of fund P=weighted average stock beta but because weight of each stock in portfolio is 1/3, simple average can be used.
So Beta=(0.7+1.2+1.5)/3=1.13
c. According to the logic given in b, required return will also be simple average.
Required return of fund P=(8.79+11.14+12.55)/3=10.83%
d. For a portfolio consisteing of equal weighted stocks all of which have equal standard deviations, standard deviation of portfolio would be same as standard deviation of stock. So correct answer is III.
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