The Capital Asset Pricing Model: 1. Assume the risk free rate equals Rf = 4%, an

Question

The Capital Asset Pricing Model: 1. Assume the risk free rate equals Rf = 4%, and the expected return on the market portfolio is E [RM] = 12% and standard deviation M = 15%. (a) What is the equilibrium market risk premium (that is, the expected return on the market portfolio minus the risk free rate)?

(b) If a certain stock has a realized return of 14%, what can we say about the beta of this stock?

(c) If a certain stock has an expected return of 14%, what can we say about the beta of this stock?

2. Apple stock has an average return of 12% and a beta of 1.1. Google stock has an average return of 14% and a beta of 1.2. The risk free rate is 5% and the expected return on the market is 10%. If you can only pick one stock to buy, which one would you pick? Explain your answer.

Explanation / Answer

rf= 4% E(RM)=12% standard deviation=15% a) Equilibrium Makrket Risk Premium: (12%-4%) 8% b) We cannot say anything about the beta as to dtermine we need to know the expected return which in general will not be equal to the realised return. c) Expected Return = E[RM]=Rf+ beta (E[Rm]-Rf) Beta= (14%-4%)/ (12%-4%) 1.25 2) Google Apple Expected Return 5+1.2(10-5) 5+{1,1(10-5) 11 10.5 Standard Deviation (11-14)2 (10.5-12)2 3 1.5 Coefficient Standard Deviation/Avg return Standard Deviation/Avg return 3.0/14 1.5/12 0.214286 0.125 Answer: We will pick apple as it has low risk as compared to google.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.