Question

1. Unless otherwise specified, please report answers in percent rounded to 2 decimal places (e.g. if the answer is .01235, report 1.25) a. Suppose our representative investor has a risk aversion coefficient A=2. If the standard deviation on the market is 20%, what is the market risk premium? b. We measure the beta of apple stock with the market at 0.9. If the market risk premium (E[m – r;]) is 8%, what is the expected excess return on apple? C. Assume a risk-free rate of 0% and a return on the market 10%. What is the CAPM expected return of a stock whose covariance with the market is 0.01 if the variance of the market it 0.02? d. Assume CAPM holds: What must be the beta of a portfolio with E(rP) = 18%, if rf = 6% and E(TM) = 14%?

Answer 1

a) Market Risk Premium: = Standard deviation of market *0.5/ Aversion coefficient = 20 *0.5/2 = 10/2 = 5.00 b) Expected Excess return on Apple stock: = Beta * Market risk premium = 0.9*8.00 = 7.20 c) Computation of expected return using = Rf+B (Rm - RF) = 0% +(Covariance / om^2)(Rm-Rf) = 0.00 + (0.01/0.02)*(10.00 -0.00) = 5.00% d) Computation of Beta using CAPM: EⓇ = Rf + B(Rm - Rf) B = (E-Rf) / (Rm - Rf) '= (18.00 - 6.00)/(14.00-6.00) '= 12.00 / 8.00 '= 1.50