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Unformatted text preview: Hence, the portfolio's expected rate of return is the riskfree rate, 4%. c. Using the SML, the fair rate of return for a stock with β = –0.5 is: E(r) = 4% + (–0.5)(12% – 4%) = 0.0% The expected rate of return, using the expected price and dividend for next year: E(r) = ($44/$40) – 1 = 0.10 = 10% Because the expected return exceeds the fair return, the stock must be underpriced. Chapter 18: 5 (Page 604) a. E(r) σ β Portfolio A 11% 10% 0.8 Portfolio B 14% 31% 1.5 Market index 12% 20% 1.0 Riskfree asset 6% 0% 0.0 The alphas for the two portfolios are: α A = 11% – [6% + 0.8(12% – 6%)] = 0.2% α B = 14% – [6% + 1.5(12% – 6%)] = –1.0% Ideally, you would want to take a long position in Portfolio A and a short position in Portfolio B. b. If you hold only one of the two portfolios, then the Sharpe measure is the appropriate criterion: S A = S B = Therefore, using the Sharpe criterion, Portfolio A is preferred....
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This note was uploaded on 03/20/2012 for the course FINA 469 taught by Professor Zhang during the Spring '08 term at South Carolina.
 Spring '08
 zhang

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