Question

security	beta	Standard deviation	Expected return
S&P 500	1.0	20%	10%
Risk free security	0	0	4%
Stock d	( )	30%	13%
Stock e	0.8	15%	( )
Stock f	1.2	25%	( )

3) If stock F has an average return of 12%,

1. find the expected return based on CAPM equation and beta 1.2

2. find the abnormal returns, alpha

Answer 1

3)	Given,
	Average return of F	12%
1)	Beta of Stock F	1.2
	Expected return on market (Rm)	10%
	Risk free rate (Rf)	4%
	We know,
	As per CAPM,
	Expected return= Rf+(Rm-Rf)*Beta
	4+(10-4)*1.2
	11.20%
2)	Alpha= Actual return i.e. average return- Expected return
	12-11.20
	0.8
	Calculation of missing figures in the table
	Calculation of beta of stock D
	Expected return on market (Rm)	10%
	Risk free rate (Rf)	4%
	Return on stock D	13%
	We know,
	Expected return= Rf+(Rm-Rf)*Beta
	13=4+(10-4)*Beta
	13-4= 6*Beta
	Beta= 9/6
	Beta= 1.5
	Calculation of expected return of E
	Expected return on market (Rm)	10%
	Risk free rate (Rf)	4%
	Beta of stock E	0.8
	Beta of stock F	1.2
	We know,
	Expected return= Rf+(Rm-Rf)*Beta
	Stock E= 4+(10-4)*0.8	8.80%