BUS 415: INVESTMENT AND PORTFOLIO MANAGEMENT
SPRING 2011, AUBG
Quiz 4(a)
Problem 1 (10 points):
Stock XYZ has an expected return of 12% and risk of
β
= 1. Stock ABC has an
expected return of 13% and risk of
β
= 1.5. The expected return of market is 11%,
and the riskfree rate is 5%.
a.
(3 points) According to the CAPM, which stock is a better buy?
]
R
)
R
(
E
[
R
)
R
(
E
F
M
i
F
i

β
+
=
%
11
%]
5
%
11
[
0
.
1
%
5
)
R
(
E
XYZ
=

+
=
%
14
%]
5
%
11
[
5
.
1
%
5
)
R
(
E
ABC
=

+
=
E(R
XYZ
) = 11%
requited vs. 12% actual
E(R
ABC
) = 14%
requited vs. 13% actual
Therefore, choose stock XYZ.
b.
(5 points) What is the alpha of each stock? Plot the SML and each stock’s risk
return point on the graph.
]
R
)
R
(
E
[
R
)
R
(
E
F
M
i
i
F
i

β
+
α
=

%
1
%)]
5
%
11
(
0
.
1
%
5
[
%
12
(
XYZ
=

+

=
α
%
1
%)]
5
%
11
(
5
.
1
%
5
[
%
13
(
ABC

=

+

=
α
So, XYZ stock is underpriced and ABC is overpriced.
c.
(1 points) The risk free rate if 8% now and the expected return on the market
portfolio is 16%. A firm considers a project that is expected to have a beta of 1.4
What is the required rate of return on the project?
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 Spring '11
 john
 Capital Asset Pricing Model

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