7. CAPM, portfolio risk, and return Consider the following information for three
ID: 2742910 • Letter: 7
Question
7. 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 coefficients is between 0 and 1.)
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 (rM - rRF)? 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.
Beta 0.7 1.1 1.5 Stock Expected Return Standard Deviation 9.01 % 10.73 12.45 16 16Explanation / Answer
Answer Step-1 1. Market Risk Premium (rM-rRF) Formula Expected Return= Rf+(rM-rRF)bA Using Stock A 9.01%= 6%+(rM-rRF)0.7 1.28%= 6%+(rM-rRF) rM-rRF= 6%-1.28%= 4.72% Using Stock B 10.73%= 6%+(rM-rRF)1.1 0.97%= 6%+(rM-rRF) rM-rRF= 6%-0.97%= 5.03% Using Stock C 12.45%= 6%+(rM-rRF)1.5 0.83%= 6%+(rM-rRF) rM-rRF= 6%-0.83%= 5.17% 2 Beta of Fund P Stock A kA = kRF + (kM - kRF)b 9.01%=6%+(4.72%)b 9.01%=10.72%b b= 0.84 Stock B kB= kRF + (kM - kRF)b 10.73%=6%+(5.03%)b 10.73%=11.03%)b b= 0.97 Stock C kC= kRF + (kM - kRF)b 12.45%=6%+(5.17%)b 12.75%=(11.17%)b b=1.14 3 Required Return Stock A kA = kRF + (kM - kRF)b 6%+4.72%X0.84 9.96% Stock B kB = kRF + (kM - kRF)b 6%+5.03%X0.97 10.87% Stock C kC = kRF + (kM - kRF)b 6%+5.17%X1.14 11.89%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.