Question

question 2

Examples on Asset Pricing Mode 1. You are given the following equilibrium expected returns and risks 7 (R- es-2 E(RA)- 12.2 % ; E(Ra)-15.5 % ; Ba-1.25 BA-0.7; .£{{¢*6,4 *రి 6 a What is the equation of the Security Market Line? b. A portfolio, made up of A (above) and another security, has a beta of 1.10 and expected return of 13 %. Which one would you rather buy- A alone or the portfolio? Why? (R) 4-6 7 13- oveA aBA c. Given the SML above, what is the maximum you will be willing to pay today for a stock that has a beta of 0.6, if the expected price next year is $48 and it is expected to pay dividends of $1.00 per share? e Cai . t 2 d. If investors become more risk averse, will the expected return for B be higher or lower than 15.5%67 H14HE 2. You are given the following information from a market in equilibrium: E(RA) 15.6 % ; E(Ra)- 12.4 % ; BA-1.2; Ba-0.8 a. What is the equation of the Security Market Line based on the CAPM? 2 ( sa b. What is the equilibrium expected return on a portfolio created from 45% A and 55 % B. 13. c. The estimated expected on a stock C is 14 %. If the beta of C is 1.3, is C overvalued or undervalued? (s) .147 147 otvAuo d. Suppose the risk-free rate goes up by 1 % ( 100 basis points), what will be the new expected return for A? 6(i2 0.0st e. If the expected return on the market goes up by 1% ( 100 basis points) what will be the new expected return for A? IRi aoc4 (air ) 0.06 40096 3. Suppose asset returns follow a 2-factor APT and you are given the following equilibrium expected rates of return: Security i A E(R) 6.6% bu 0.2 ba -0.1 0.3 -0.2 0.5 В 12.75% 9.9% 0.6 C What is the equation of the APT? (.06, .075, .09). Ca)o.6 What is the expected return on a portfolio of B and C with zero sensitivity to factor 1? (s 0. eSuppose there is a stcurity, D with sensitivity of zero to factor 1, and 0.2 to factor 2, and expected return of 9.675 % , will you buy it? Why? e (rt) An investor believes that the expected returns above (table) come from the CAPM instead of the APT but agrees with the risk-free rate estimated above. The analyst uses security B to demonstrate his point. What is his estimate of the market portfolio assuming the beta of B is 0.8? (tr a. b. d. १ 4. Suppose asset returns follow a 2-factor APT and you are given the following equilibrium rates of return: Stock i E(R.) bi 0.208 b2i 1.1 1.1 0.8 C 0.7 D -0.2 0.145 E 0.216 1.2 a What is the equation of the APT? E(hi -0 o.7 a. b. Suppose there is portfolio, P, with observed expected return of 15.6 %. P has sensitivity of 1.32 to factor l and zero sensitivity to factor 2. Is P undervalued or overvalued?

Answer 1

The solution for Q2 is given below. Since risk free rate is not mentioned in your question, I am assuming it to be 6%. Dont hesitate to ask for further clarifications.

- expected stuen. Q2. a) SML = Rf + ß (ECM) – RCC). Risk forse rate systematic 6 451. A = 6+ 1.2 (15,6-0 = 17,52 x 45% = 7.88% 55% B = 6 + 0.8 (12.4-6 = 11.12 x 55% = 6·116% 13.996% c) C= 6+ 1.3/14-C) - F 16.4%. + OVERVALUED d) A = 7+ 1:2 (16:6-7) – 17.32%. e) A = 6+ 1.2 (16.6-6) = 15.4°/