Question

You are given the following set of market conditions: the risk-free rate = 5%, expected rate of return of the market portfolio = 12%. Compute the expected return for the following risky securities:
APPL: Beta = 1.25
BA:     Beta = 1.10
C:        Beta = 0.75

Draw a graph of the Security Marker Line (SML) based on the information given in part 1 and plot the three securities.

Answer 1

Answer-

Given

risk free rate = 5 %
Rate of return for market portfolio = 12 %
Expected return

Return = risk free rate  + Beta x ( Rate of return for market portfolio - risk free rate )

Return APPL
= 5 % + 1.25 x ( 12 % - 5 %)
= 5 % + 1.25 x 7 %
= 5 % + 8.75 %
= 13.75 %
Return  BA
= 5 % + 1.10 x ( 12 % - 5 %)
= 5 % + 1.10 x 7 %
= 5 % + 7.7 %
= 12.7 %
Return C
= 5 % + 0.75 x ( 12 % - 5 %)
= 5 % + 0.75 x 7 %
= 5 % + 5.25 %
= 10.25 %

Given below is the Security Marker Line (SML) with plotted securities

r f = risk free rate
E(r) = Expected return
E (r m) = Rate of return for market portfolio

El) 13.25k • App! (13.15)) 1272 I security Morset line (SML) * BA (12.7%) - c(logo) % - 12 10:2871 of -5% 0.75 1 2 125 B (beta)