FE_Assignment_3_A(1).pdf

# FE_Assignment_3_A(1).pdf - Assignment 3 Risk Return and the...

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Assignment 3: Risk, Return and the CAPM (and APT and FF) Please show all your work. Also make sure to put your full name on the first page of your completed assignment . 1. ( 5 pts) Given the following information about securities A and B, ࠵? # = 2%, ࠵? ) = 1.5, ࠵? - = .5 and the market price of risk, ࠵? = 7.5% under the CAPM: a. What are the required returns to each of A and B? E( ࠵? ) ) = ࠵? # + ࠵? ) ∗ ࠵? = 2% + 1.5*7.5% = 13.25% E( ࠵? - ) = ࠵? # + ࠵? - ∗ ࠵? = 2% + .5*7.5% = 5.75% b. What is the ࠵? of an equally weighted portfolio of A and B? E( ࠵? ),- ) = .5* E( ࠵? ) ) + 5* E( ࠵? - ) = .5*13.5 + .5*5.75 = 9.5% Then, E( ࠵? ),- ) = ࠵? # + ࠵? ),- ∗ ࠵? so ࠵? ),- = (9.5% - 2%)/75% = 1 c. Would you ever hold this portfolio of A and B alone? No, you would never hold it in isolation because you would still have the portfolio’s specific risk. Also, in the CAPM equilibrium you only hold the market portfolio; thus, you hold A in its proportion in the market portfolio, 23 4 23 5 . Similarly, for B, 23 6 23 5 . 2. (5 pts) Given the following information about 2 firms X and Y about the probability distribution of returns for each: Probability X’s Returns

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