Question

The following three stocks are available in the market: E(R) β Stock A 10.5 % 1.27 Stock B 13.7 1.07 Stock C 16.2 1.47 Market 14.1 1.00 Assume the market model is valid. The return on the market is 14.9 percent and there are no unsystematic surprises in the returns. What is the return on each stock? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Return Stock A % Stock B % Stock C % Assume a portfolio has weights of 20 percent Stock A, 35 percent Stock B, and 45 percent Stock C. The return on the market is 14.9 percent and there are no unsystematic surprises in the returns. What is the return on the portfolio? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Return on the portfolio %

Answer 1

As per the Market Model, the Return on Stock is as under
R_s = E(R_s)+ *[R_M- E(R_M)] +
R_s :Return of Stock
E(R_s):Expected Return of Stock
: Beta of Stock
R_{M :} Actual Return of Market
E(R_M): Expected Return of Market


Since there are unsystematic shocks in returns ,
Using the market model, if the return on the market is 14.9 % and there are no unsystematic surprises, the return for each individual stock is:
R_A = 10.5% + 1.27(14.9% – 14.1%)
R_A = 11.52%

R_B= 13.7% + 1.07(14.9% – 14.1%)
R_B= 14.56%

R_C= 16.2% + 1.47(14.9% – 14.1%)
R_C = 17.38%

Stock	Expected Returns	Market Model Returns	weights	ER X weights	Market Model X Weights
A	10.50%	11.52%	20%	2.10%	2.30%
B	13.70%	14.56%	35%	4.80%	5.09%
C	16.20%	17.38%	45%	7.29%	7.82%
Return for Portfolio				14.19%	15.22%

Return for Portfolio based on Market Model is 15.22%