_CAPM_ Practice Problems

_CAPM_ Practice Problems - 40 with the market portfolio...

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1 FINA 3104 Practice Problems Fall 2011 The Capital Asset Pricing Model (CAPM) 1. True or False (Briefly Explain) (a) If the CAPM holds, the return of a well-diversified portfolio with no diversifiable risk and a = 1 is perfectly correlated (i.e., correlation = 1) with the market. (b) If the CAPM holds, a very risk-averse investor should hold predominantly low-beta stocks. (c) A security that lies below the Security Market Line (SML) is underpriced. 2. CAPM, Riskfree Rate, and SML Suppose the CAPM holds. Stock A has an expected return of 15% and a covariance of 20% with the market portfolio, while Stock B has an expected return of 25% and a covariance of
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Unformatted text preview: 40% with the market portfolio. There are other stocks in the market portfolio (and we do not know how many). (a) What is the riskfree rate? (b) What is the reward-to-risk ratio of the market portfolio (i.e., market excess return divided by market variance)? (c) Suppose Stock X has a beta of 2 and an expected return of 30%. What are the expected return on the market portfolio and the variance? (d) Draw the Security Market Line (SML) and label the axes. Show in the diagram where you would find Stocks A, B, and X, as well as the market portfolio. 3. Recommended Problems from the Textbook (BKM) CAPM Implications: Chapter 9 Problems 10-19 (P.340-341)...
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This note was uploaded on 11/27/2011 for the course FINA 3104 taught by Professor Darwin during the Spring '11 term at HKUST.

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