Question

9. The existence of a risk-free asset results in the derivation of:

A. the security market line (SML)

B. the characteristic line

C. the efficient frontier

D. the capital market line (CML)

10. If the market portfolio has an expected return of 0.12 and a standard deviation of 0.40, and the risk-free rate is 0.04, what is the slope of the security market line?

A. 0.08

B. 0.20

C. 0.04

D. 0.12

11. A particular asset has a beta of 1.2 and an expected return of 10%. The expected return on the market portfolio is 13% and the risk-free is 5%. Which of the following statement is correct?

A. This asset lies on the security market line.

B. This asset lies above the security market line.

C. This asset lies below the security market line.

D. Cannot tell from the given information.

12. A stock that pays no dividends is currently priced at $40 and is expected to increase in price to $45 by year end. The expected risk premium on the market portfolio is 6% and the risk-free is 5%. If the stock has a beta of 0.6, the stock is

A. overpriced

B. underpriced

C. appropriately priced

D. Cannot tell from the given information

Answer 1

Answer summary

9. A. the security market line (SML)

10. A. 0.08

11. C. This asset lies below the security market line.

12. B. underpriced

9)

Answer is the CML because the CML is drwan from the risk free asset ot wchih rose to the formation fo efficient forntier. so it is.

Reasons for others to be fasle:

SML line is drawn from the Market risk Beta.

The characteristic line or SML is drwan for mesuring the performance.

The efficinet forntier is derived with the CML line on risk vs return graph.

10)

slope of the security market line market rreturn - risk free rate

=0.12-0.04

slope of the security market line = 0.08

11)

According to CAPM,

Expected return= Risk free rate + beta * (market return- risk free rate)

=5+1.2*(13-5)

Expected return= 14.6% and lies BELOW THE SML

market is giving the return 13% and our expected return is 14.6%, so it is over priced sol it lies BELOW the SML.

stocks wich are under priced lies above the sml and if the returnsoare equal then it lies on sml

12)

Expected return= Risk free rate + beta * Risk premium

=5+0.6*6

Expected return = 8.60%

Holding period return (HPR) = ( increase price / current price)-1= (45/40)-1

HPR= 12.5%

as expected return is less than HPR it is underpriced.

if it is greater then it will be overpriced or else appropriately priced.