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CHAPTER 13 B-241 13. CAPM states the relationship between the risk of an asset and its expected return. CAPM is: E(R i ) = R f + [E(R M ) – R f ] × i Substituting the values we are given, we find: E(R i ) = .052 + (.11 – .052)(1.05) = .1129 or 11.29% 14. We are given the values for the CAPM except for the of the stock. We need to substitute these values into the CAPM, and solve for the of the stock. One important thing we need to realize is that we are given the market risk premium. The market risk premium is the expected return of the market minus the risk-free rate. We must be careful not to use this value as the expected return of the market. Using the CAPM, we find: E(R i ) = .102 = .045+ .085 i i = 0.67 15. Here we need to find the expected return of the market using the CAPM. Substituting the values given, and solving for the expected return of the market, we find: E(R i ) = .135 = .055 + [E(R M ) – .055](1.17) E(R M ) = .1234 or 12.34% 16. Here we need to find the risk-free rate using the CAPM. Substituting the values given, and solving for the risk-free rate, we find: E(R i ) = .14 = R f + (.115 – R f )(1.45) .14 = R f + .16675 – 1.45R f R f = .0594 or 5.94% 17. a. Again we have a special case where the portfolio is equally weighted, so we can sum the returns of each asset and divide by the number of assets. The expected return of the portfolio is: E(R p ) = (.16 + .048)/2 = .1040 or 10.40%

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B-242 SOLUTIONS b. We need to find the portfolio weights that result in a portfolio with a of 0.95. We know the of the risk-free asset is zero. We also know the weight of the risk-free asset is one minus the weight
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## This document was uploaded on 10/31/2011 for the course FIN 3403 at University of Florida.

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