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03-PS8-CAPM - MIT Sloan School of Management J Wang E52-456...

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MIT Sloan School of Management J. Wang 15.407 E52-456 Fall 2003 Problem Set 8: Portfolio Choice Due: December 2, 2003 1. (BKM) Are the following true or false? (a) Stocks with a beta of zero offer an expected rate of return of zero. (b) The CAPM implies that investors require a higher return to hold highly volatile securities. (c) You can construct a portfolio with a beta of 0 . 75 by investing 0 . 75 of the investment budget in bills and the remainder in the market portfolio. 2. (BKM-revised) IN 1999 the rate of return on short-term government securities (perceived to be risk-free) was about 5%. Suppose the expected rate of return required by the market for a portfolio with a beta of 1 is 13%. According to the CAPM: (a) What is the expected rate of return on the market portfolio? (b) What would be the expected rate of return on a stock with β = 0? (c) Suppose you consider buying a share of stock at $100. The stock is expected to pay $5 dividend next year and you expect it to sell then for $108. You calculated the β of the stock to be 0.5. Is the stock overpriced or underpriced?
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