You have the following information about three securities A, B, and C: Security Expected return Beta...

You have the following information about three securities A, B, and C:

Security	Expected return	Beta
A	24%	2.0
B	7%	0.5
C	2%	0

Given this information, you can definitely conclude that:

A.
All three securities are underpriced
B.
A, B, and C are fairly priced
C.
At least two of the three securities are mispriced
D.
At least one of A, B, or C is mispriced

Solutions

Expert Solution

If CAPM holds, we have following formula to calculate the expected return on stocks

Expected Return of the stock = risk free rate + β* the market risk premium

As the beta of security C is 0, therefore we can assume that its expected return is risk free rate

Now

Expected Return of the stock A = 24%

Risk free rate = 2%

The market risk premium =?

And β of stock A = 2.0

Putting all the values in the equation we can get

24% = 2% + 2.0 * the market risk premium

Or market risk premium = (24% -2%)/2 = 11%

Similarly for stock B

Expected Return of the stock B = 7%

Risk free rate = 2%

The market risk premium =11% (as calculated above)

And β of stock B = 0.5

Putting all the values in the equation we can get

7% = 2% + 0.5 * 11%

Or 7% ≠ 7.5%

Based on these values, it is a violation of CAPM model because the betas and expected returns are not consistent with CAPM.

Therefore At least one of A, B, or C is mispriced

Correct answer is option: D. At least one of A, B, or C is mispriced

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

Three securities have the following expected returns and beta: Securities Return Beta A 10% 0.65 B...

Three securities have the following expected returns and beta: Securities Return Beta A 10% 0.65 B 18% 1.37 C 25% 0.22 a) Calculate the expected return of a portfolio if all the securities are held equally. b) Given the standard deviation for the securities A, B, and C is 12%, 14% and 18% while its covariance is 60, 20, and -30 respectively, estimate the standard deviation of this portfolio. c) Based on the risk-return relation, redesign the securities holding proportion...

You hold a portfolio with the following securities: Security Portfolio weight Beta Expected Return Driscol Corporation...

You hold a portfolio with the following securities: Security Portfolio weight Beta Expected Return Driscol Corporation 29% 3.3 38% Evening Corporation 49% 1.7 20% Frolic Corporation 22% 0.2 5% The expected portfolio return is Blank 1. Calculate the answer by read surrounding text. %. Round to the nearest 0.01% (drop the % symbol). E.g., if your answer is 21.93%, record it as 21.93.

Suppose you observe the following situation: Security Beta Expected Return Assume these securities are correctly priced....

Suppose you observe the following situation: Security Beta Expected Return Assume these securities are correctly priced. peat co. 1.20 11.0 Repeat co. 0.65 9.9 Based on the CAPM, what is the expected return on the market? What is the risk-free rate? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.) Expected return on market % Risk-free rate %

You are given the following information on two securities. Security Expected Return Standard Deviation of Returns...

You are given the following information on two securities. Security Expected Return Standard Deviation of Returns A 10.0% 14.0% B 16.0% 12.0% The correlation between the returns on the two securities is +0.6. The standard deviation of returns of a portfolio earning an expected return of 14.0 percent is closest to: Group of answer choices A 11.4%. B 9.3%. C 27.1%. D 12.7%.

1. Assumed the betas for securities A, B, and C are shown here. Security Beta A...

1. Assumed the betas for securities A, B, and C are shown here. Security Beta A 1.39 B .75 C -.93 A. Calculate the change in return for each security if the market experiences an increase in its rate of return of 13.7% over the next period B. Calculate the change in return for each security if the market experiences a decrease in its rate of return of 10.3% over the next period C. (Select he best choice below.) A....

You have been given information about the expected performance of two securities, A and B, over...

You have been given information about the expected performance of two securities, A and B, over the next year. Assume that the performance of the securities largely follow the performance of the economy. For the particular year, four scenarios of economic performance are expected for each respective security and are as advised below. Based on this information, you have been requested to undertake a performance analysis with a view to forming a two-security portfolio. The correlation coefficient of the securities...

You are given the following table: Securities Weight Beta Expected return Variance of return 1 0.3...

You are given the following table: Securities Weight Beta Expected return Variance of return 1 0.3 0.6 0.7 0.06 2 0.4 0.8 0.9 0.08 3 0.3 1.1 1 0.13 Variance of market portfolio return = 0.07 Given the assumption of a single factor model, calculate the following: The residual variance of each of the above stocks; The expected return on this 3-stock portfolio; The beta factor of this 3-stock portfolio; The variance of this 3-stock portfolio.

You have a portfolio of three stocks: Stock A, Stock B, and Stock C. The expected return...

You have a portfolio of three stocks: Stock A, Stock B, and Stock C. The expected return of Stock A is 8%, the expected return of Stock B is 10%, and the expected return of Stock C is 12%. The expected return of the portfolios is 10.5%. If the weight of asset B is three times the weight of asset A, what are the weights for the three assets?

Investments A, B, and C all have the following characteristics: A B C Expected Return 10%...

Investments A, B, and C all have the following characteristics: A B C Expected Return 10% 10% 10% Standard Deviation 8% 8% 8% Skewness 1.5 0.4 -0.8 Excess Kurtosis -0.6 0 1.2 For an investor who is most concerned about not losing principal, the best investment and the worst investment are likely to be, respectively: A.) A the best and B the worst B.) B the best and A the worst C.) B the best and C the worst D.)...

You have the following information for Stock A and Stock B: Expected rate of return Stock...

You have the following information for Stock A and Stock B: Expected rate of return Stock A: .12 Stock B: .06 Standard deviation: Stock A: .9 Stock B: .5 Correlation between the two stocks: .80 If you invest $600 and $400 in Stock A and Stock B respectively, what is the standard deviation of the portfolio?

Subjects