Portfolio Management - Portfolio Management Section 1
- Option : B
- Explanation : In the capital asset pricing model, the market risk premium is the difference between the return onthe market and the risk free rate, which is equivalent to the return in excess of the market return.
- Option : C
- Explanation : The security market line is a graphical representation of the capital asset pricing model, with beta risk on the x-axis and expected return on the yaxis.
| Stock | A | B | C |
| Investor’s Estimated Return | 11.96% | 10.88% | 16.39% |
| Beta | 1.6 | 1.2 | 0.96 |
If the risk free rate is 2.20% and market return is 9.65%, which of the three securities is most likely undervalued?
- Option : C
- Explanation : For a stock to be undervalued, its estimated return should be greater than the required return (from CAPM). This condition is true only for stock C. The required return is calculated using CAPM. Required return for C = 0.022 + 0.96 * (0.0965 - 0.022) = 9.35%. Since the estimated return of 16.39% higher than the required return of 9.35%, the stock is undervalued.
64. The following table shows data for the stock of ABC and a marketindex.
| Expected return of ABC | 10% |
| Expected return of the market-index | 9% |
| Risk free rate | 4% |
| Standard deviation of ABC returns | 15% |
| Standard deviation of market-index returns | 12% |
| Correlation of ABC and market-index returns | 0.5% |
Based on the capital asset pricing model (CAPM), ABC is most likely:
| Investor | Expected Standard Deviation | Beta |
| Daniel | 30 | 1.60 |
| David | 25 | 1.80 |
| Diana | 20 | 1.40 |
Given that the expected market risk return is7% and the risk-free rate is 2.5%, what is the expected return for Daniel’s security?
- Option : B
- Explanation : The expected return can be calculated using the following equation: E (Ri)= Rf+ β (E (Rm) −Rf) E (Ri)= 2.5% + 1.60 (7%−2.5%)= 9.7%
