# nhw6a - Homework 6 1 Write out the CAPM Model and explain...

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Homework 6 1. Write out the CAPM Model and explain each part. E(ri) = rf + βi [E(rM) - rf] E(ri) =expected return of the security i E(rM)= the expected return on the market Rf= the risk free rate Βi= the beta or a measurement of the extent that security i’s returns and the market’s returns move together. 2. Draw a Beta by expected return graph. With a risk free rate of 5% and a return of the market portfolio at 12%. Add a rational security market line. A. Add to your graph a negative alpha stock and explain why it is not worth buying. 0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0 0.2 0.4 0.6 0.8 1 1.2 Series1 Series2 Linear (Series1) The pink dot is the negative alpha stock, it is not worth buying as it has an expected return that is less than what we can recreate by mixing t-bills and the market portfolio together, for the same level of risk we can have a higher expected return. B. How can you make an expected profit only subject to firm specific risk?

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## This note was uploaded on 10/15/2011 for the course ECON 171 taught by Professor Hull during the Spring '09 term at Brandeis.

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nhw6a - Homework 6 1 Write out the CAPM Model and explain...

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