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ps3sol - Financial Economics V 3025 Fall 2009 Rajiv Sethi...

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Unformatted text preview: Financial Economics V 3025 Fall 2009 Rajiv Sethi 5B Lehman Phone: 854 5140 [email protected] Problem Set 3: Solutions 1. The published betas are: & INTC = 1 : 17 ; & MMM = 0 : 77 ; & ED = 0 : 28 According to the Capital Asset Pricing Model INTC should have the highest expected return, and ED the lowest. See spreadsheet for remainder of question. 2. See spreadsheet. 3. If the market portfolio has expected return E ( r m ) = 12% and standard deviation ¡ m = 20%, and the risk-free rate is 5% ; the security market line is given by E ( r i ) = r f + & i ( E ( r M ) & r f ) = 5 + 7 & i (a) An asset with expected return E ( r i ) = 19% and & i = 1 : 75 is underpriced since 5 + 7 & i = 17 : 25% : (b) An asset with expected return E ( r i ) = 2% and & i = & : 25 is overpriced since 5 + 7 & i = 3 : 25% : (c) An asset with expected return E ( r i ) = 6%, standard deviation ¡ i = 10% and correlation coe&cient with the market portfolio ¢ im = 0 : 5 is overpriced. To see this, note that cov ( r i...
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