Question

A.

Alpha and the CAPM A stock with a beta of 0.77 has an expected return of 12% and an alpha of 1.5% when the market expected return is 13% . What must be the risk free rate that satisfies these conditions?

2.14%

2.13%

2.16%

2.15%

B.

Portfolio Beta An investor places $6,000 in Stock A, $5,000 in Stock B and $12,000 in Stock C. Stock A has a beta of 1.05, Stock B has a beta of 1.25 and Stock C has a beta of 1.4. What is the resulting portfolio beta?

1.27

1.28

1.35

1.23

C.

CAPM Implications Jill has low risk aversion and Jack has high risk aversion. Both go to Sherry, a financial planner, for investment advice. Ignoring taxes and liquidity concerns according to the CAPM Sherry should

I. recommend the same risky portfolio for both clients

II. recommend a higher risk stock portfolio for Jack than for Jill

III. recommend that Jill put more money in the risky portfolio than Jack

IV recommend identical complete portfolios for both clients

II, III

I, III

IV

I, IV

Answer 1

Question - A

Alpha of 1.5% means, excess of expected return over the CAPM model prediction. Thus, 12% is the expected return but alpha is 1.5% it implies that CAPM model value = 12 - 1.5 = 10.5%

CAPM model = Rf + Beta ( Rm - Rf) = 10.5

Here Rf = Risk free rate ....... which had to be derived from equation

Rm = Market rate of return ......... Given = 13

Beta = 0.77

Rf + 0.77 ( 13 - Rf) = 10.5

Rf + 10.01 - 0.77 Rf = 10.5

0.23 Rf = 0.49

Rf = 0.49 / 0.23 = 2.13 .............. Select Option - B

Question - B

	Amount	Weight	Beta	W*B
Stock - A	6000	0.26087	1.05	0.273913
Stock - B	5000	0.217391	1.25	0.271739
Stock - C	12000	0.521739	1.4	0.730435
	23000			1.28

In the above table, weights are obtained by dividing individual amount with total of amounts. i.e 6000/23000, 5000/23000 and 12000/23000. In the last column we multiply beta values with respective weights and finally total up the last column to get portfolio beta = 1.28 ............ Select Option - B

Question - C

Select - Option - B .......... I, III

The term same risky portfolio implies a portfolio that matches the risk aversion of the client.