Please be as descriptive as possible so I can understand it better 6. Suppose th

Question

Please be as descriptive as possible so I can understand it better 6. Suppose that the yield to maturity on risk-free assets (in) is 2.0%, and the expected rate of return on the "market portfolio" (Rm") is 12%. a. What is the "risk premium" on the market portfolio in this case? b. Sketch the Security Market Line in this case. c. According to the CAPM model, what is the equilibrium expected rate of return for a stock with a beta of 0.80? d. If the market expects a rate of return of 15% for a stock, then according to the CAPM model, what must its beta be? According to the CAPM, what must be the expected rate of return on a portfolio of assets composed of 1/3 risk-free asset and 2/3 shares of stock with a beta of 1.2? What must be the beta of the portfolio? e.

Explanation / Answer

a) Risk Premium = Market Return - Risk-free rate = 12% - 2% = 10%

c) Using CAPM, E(R) = Rf + beta x MRP = 2% + 0.8 x 10% = 10%

d) E(R) = Rf + beta x MRP => 15% = 2% + beta x 10%

=> Beta = (15% - 2%) / 10% = 1.3

e) E(R) of stock = 2% + 1.2 x 10% = 14%

E(R) of portfolio = 1/3 x 2% + 2/3 x 14% = 10%

Beta of portfolio = (10% - 2%) / 10% = 0.8 or beta = 2/3 x 1.2 = 0.8

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