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Unformatted text preview: portfolio is 14%. On the basis of the capital asset pricing model what is the required return on an investment with beta = 2? Answers: 1) CAPM equation: E[R] = R f + b{E[R m ]  R f }. Plug in the expected return of the market, stock X and riskfree asset to get: 16 = 4 + b{12  4}. b=1.5 2) CAPM equation: E[R] = R f + b{E[R m ]  R f }. Plug in the expected return of the market, stock X and riskfree asset to get: 16 = 4 + b{12  4}. b=1.5. b=cov(x,market)/var(market). Therefore. B=1.5=[cov(x,market)/.2]. cov=30%. 3) CAPM equation: E[R] = R f + b{E[R m ]  R f }. For stock X: 12% = R f + 1*{E[R m ]  R f }. For Stock Y: 10% = R f + .5*{E[R m ]  R f }. These two equations imply that {E[R m ]  R f } = 4% and R f = 8% 4) Plug b=2 into the CAPM equation: E[R i ] = R f + b{E[R M ] – R f } = .04 + 2*{.14.04} = .24 or 24%...
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This note was uploaded on 04/12/2008 for the course ECON 435 taught by Professor Chabot during the Winter '08 term at University of Michigan.
 Winter '08
 CHABOT

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