Excel Online Structured Activity: CAPM, portfolio risk, and return Consider the

Question

Excel Online Structured Activity: 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 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.

Open spreadsheet

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.

%

Would you expect the standard deviation of Fund P to be less than 16%, equal to 16%, or greater than 16%?

less than 16%

greater than 16%

equal to 16%

Stock Expected Return Standard Deviation Beta A 8.78 % 16 % 0.8 B 10.01 16 1.1 C 11.65 16 1.5 Laura ! 1 Your question needs to Excel Online Structured- -Mindlap-Cengage Leer X Excel Online Student we × C about.blank Apps Bookmarks R Facebook Blackboard Learn·t iCloud Find My iPh ) Outlook Web App nerdightena-TV Listings Find Lo R Facebook hell nope5 Life-Changing w Excel Online template FILE HOME INSERT DATA REVIEW VIE Tell me what you want to do 5 Cut Wrap Text B 1 u D abc Ei- . · Merge & Center. $, % , Conditional Format Insert Delete Format Sort & Find & Filter Select Clear Format Painter Formatting as Table- Alignment APM, portfolio risk, ar -Free Rate, rRF 5.50% Stock A Fonmula Stock B Formula Stock C Fonmula 6 Expected Return 7 Standard Deviation 8 Beta 8 78% 16.00% 0.80 10.01% 16.00% 1.10 11 65% 16.00% 1.50 0 Market Risk Premium, RPM 12 % Stock in Fund P 0.333333 0.333333 0.333333 of FundFP 16 Required Return of Fund P 17 Expected Return of Fund P 18 19 Sheet1 SAVED TO CENGAGE HELP IMPROVE OFFICE 2-29 PM Type here to search ^4, 11/5/2017 0

Explanation / Answer

a) Using CAPM, E(R) = Rf + beta x MRP

For A, 8.78% = 5.5% + 0.8 x MRP

=> MRP = 4.10%

b) Beta of Fund P = 1/3 x (0.8 + 1.1 + 1.5) = 1.13

c) Required Return = 5.5% + 1.13 x 4.10% = 10.15%

d) As the correlation is not perfect and all stocks have standard deviation of 16%, the portfolio would have a standard deviation of less than 16% due to the benefit of diversification.

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