Question

please answer question #1

7 1. You are given the following equilibrium expected returns and risks E(R) - 12.2%; E(Re) - 15.5% BA -0.7; Be-1.25. c( 0.460.0615 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? Ee19. 6 - OVAL BYA 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? 1. .192 d. If investors become more risk averse, will the expected return for B be higher or lower than 15.5%? HIGHER 2. You are given the following information from a market in equilibrium: E(RA) - 15.6%; E(R) - 12.4%; BA -1.2: Bo=0.8 a. What is the equation of the Security Market Line based on the CAPM? (M) b. What is the equilibrium expected return on a portfolio created from 45% A and 55% B. 13.341 c. The estimated expected on a stock C is 14%. If the beta of C is 1.3, is C overvalued or undervalued? € ) 16.4+7 144. 7 O VAL d. Suppose the risk-free rate goes up by 1% (100 basis points), what will be the new expected return for A? ER: .. EC) - 11.. e. If the expected return on the market goes up by 1% (100 basis points) what will be the new expected return for A? ElRide 0.06 (also.boßi 0.06+0oggi € (e) I. 3. 3. Suppose asset returns follow a 2-factor APT and you are given the following equilibrium expected rates of return: Security i E(R) 6.6% 0.2 -0.1 12.75% 0.3 0.5 9.9% -0.2 a. b. What is the equation of the APT? (.06..075,.09). C(R ) 0.66 +0. What is the expected return on a portfolio of B and C with zero sensitivity 2 to factor 1? LE 50.4 WC 0 6 (1) 060.01 Suppose there is a security, 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? (1 ) 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? me 144 d. 14. Suppose asset returns follow a 2-factor APT and you are given the following equilibrium rates of return: Stock i E(R) bi b i C 0.208 0.7 1.1 D 0.145 -0.2 11.1 E 0.216 1.2 0.8 . a. What is the equation of the APTO_EM .6678.67 Suppose there is portfolio, P. with observed expected return of 15.6%. P has sensitivity of 1.32 to factor 1 and zero sensitivity to factor 2. Is P undervalued or overvalued?

Answer 1

1) given E(R_A)= 12.2%, E(R_B) = 15.5%, beta of A =0.7, beta of B = 1.25

a. equation of Security market line using CAPM is K_e = R_f + beta(R_m-R_f)

where R_f = return of risk free asset, R_m = return on market portfolio, R_m-R_f = market risk premium

b. 12.2 = R_f + 0.7(R_m-R_F)

15.5 = R_f + 1.25(R_m-R_F)

solving above two equations

0.55(R_m-R_F) = 3.3

R_m-R_F = 6

R_f = 8%

K_e of another security = 8 + (1.10*6) = 14.6%

given return = 13%

as per SML security was overpriced. It is better to buy A compared to another security as the risk of A was less.

c.

calculation of K_e = 8 + (0.6*6) = 11.6%

current price = 1/1.116 + 48/1.116

= 44

d. Risk averse requires a premium for taking risks.

If investors become more risk averse then return will become higher.