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According to the Capital Asset Pricing theory, what return would be required by an investor whose...

  1. According to the Capital Asset Pricing theory, what return would be required by an investor whose portfolio is made up of 40% of the market portfolio (m) and 60% of Treasury bills (i.e. risk-free asset)? Assume the risk-free rate is 3% and the market risk premium is 7%?                                                                                          

  1. You are considering investing in the following two stocks. The risk-free rate is 7 percent and the market risk premium is 8 percent.

Stock

Price Today

Expected Price

in 1 year

Expected Dividend

in 1 year

Beta

X

$20

$22

$2.00

1.0

Y

$30

$32

$1.78

0.9

  1. Compute the expected and required return (using CAPM) on each stock.   
  2. Which asset is worth investing? Support your answer with calculations.    

  1. Which pair of stocks used to form a 2-asset portfolio would have the greatest diversification effect for the portfolio? Briefly explain.

Correlation

Stocks A & B

-0.66

Stocks A & C

-0.42

Stocks A & D

0

Stocks A & E

0.75

                                                                                   

(d)   Explain the terms systematic risk and unsystematic risk and their importance in determining    investment return.

Solutions

Expert Solution

jeff jeffy answered 7 months ago
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