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Unformatted text preview: Warm up Problems for Topic 4 (CAPM) **These questions are designed to represent elementary principles, and are NOT representative of problems that you will find on any exams. 1. You purchase stock A, which has a covariance with the market portfolio of 40%. The expected return on the market portfolio is 14%, the risk free rate is 6%, and the standard deviation of the market is 50%. 1a) What is the beta of the stock? β A = Cov ( r i , r m )/ Var ( r m ) β A =.40/(.5) 2 β A =1.6 1b) What is the risk premium on the market portfolio? Market Risk Premium=E( r m ) – r f Market Risk Premium= .14 – .06 Market Risk Premium=8% 1c) What is the expected return on stock A? E( r A )= r f + β A [E( r m )– r f ] E( r A )=.06+1.6[.14–.06] E(r A )=18.8% 2. You have $1000 to invest. You know that the risk free rate is 6%, and the standard deviation of the market portfolio is 50%. You can invest in the following securities....
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 Fall '09
 Variance, Capital Asset Pricing Model, Probability theory, Market Portfolio, Stock A

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