Question

Consider the following information:

Portfolio	Expected Return		Beta
Risk-free	7	%	0
Market	12.8		1.0
A	11.5		1.9

a. Calculate the return predicted by CAPM for a portfolio with a beta of 1.9. (Round your answer to 2 decimal places.)

b. What is the alpha of portfolio A. (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

c. If the simple CAPM is valid, is the situation above possible?

• Yes

• No

Answer 1

a) Return predicted by CAPM:-

=Rf+beta*(Rm-Rf)

=7%+1.9*(12.8%-7%)

=18.02%

b) Alpha:-

=11.5%-18.02%

=-6.52%

c) No, CAPM is not valid, as with beta of 1.9 the stock A has less return than market, whereas it should have been higher than market.