Ariana Kera ity: CAPM, portfolio risk, and return EDT Consider the following inf

Question

Ariana Kera ity: CAPM, portfolio risk, and return EDT 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 (Thet is, each of the correlation coefficients is between 0 and 1.) Stock Expected Return Standard Deviation 8.36 % 9.62 11.72 15% 15 15 Beta 0.8 1.1 1.6 Fund P has one-third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the markets in egumbrium. (That is, required rea seawal expected returns.) The data has been collected in the Microsoft Excel Online file below, Open the spreadsheet and perform the required analysis to questions below. a. wnat is the market risk premium (rM-rRF)? Round your answer to two decimal places. b. What is the beta of Fund P? Do not round intermed jate calculations. Round your answer to two decimal places. return of Fund P? Do not round intermediate calculations. Round your answer to two decimal places. Back 21

Explanation / Answer

a) Required return as per CAPM can be computed as follows -

Required return = Risk free rate + Beta x market risk premium

Now, we input the values using any of the given stocks' expected return as market risk premium will be same for all the stocks.

8.36% = 5% + 0.8 x Market risk premium

or, 3.36% = 0.8 x market risk premium

or, market risk premium = 4.20%

b) Betafund = BetaA x WeightA + BetaB x WeightB + BetaC x WeightC

Weight of each stock = 1 / 3

Betafund = (0.8 x 1 / 3) + (1.1 x 1 / 3) + (1.6 x 1 / 3) = 1.1666666 or 1.17

c) Required return for fund P = 5% + 1.1666666 x 4.2% = 9.89999 or 9.90%

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