Quiz II Practice - portfolio is 14 On the basis of the...

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Quiz 2 Practice Problems 1) Stock X and Y have returns consistent with the CAPM. Stock X has a variance of 40% and an expected return of 16%. Stock Y has a variance of 45% and an expected return of 10%. The entire market of risky securities has an expected return of 12% and a variance of 20%. If the risk-free rate is 4%, what is the beta of stock X with the market? 2) Stock X and Y have returns consistent with the CAPM. Stock X has a variance of 20% and an expected return of 16%. Stock Y has a variance of 45% and an expected return of 10%. The entire market of risky securities has an expected return of 12% and a variance of 20%. If the risk-free rate is 4%, what is the covariance of stock X with the market? 3) Stock X has a beta of 1 and an expected return of 12%. Stock Y has a beta of .5 and an expected return of 10%. If these returns are consistent with the CAPM what is the risk-free rate? 4) The Treasury bill rate is 4%, and the expected return on the market
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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 risk-free 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 risk-free 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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