20 r r X 106 r RF 86 Chapter 5 5 6 5 2 a The regression graph is

20 r r x 106 r rf 86 chapter 5 5 6 5 2 a the

This preview shows page 5 - 7 out of 7 pages.

Beta 20 1.0 2.0 r(%) r X = 10.6% r RF = 8.6%
Image of page 5
Chapter 5: 5 - 6 5-2 a. The regression graph is shown above. Using a speadsheet, we find b = 0.62. b. Because b = 0.62, Stock Y is about 62 percent as volatile as the market; thus, its relative risk is about 62 percent of that of an average firm. c. 1. Total risk ) ( 2 Y σ would be greater because the second term of the firm's risk equation, 2 eY 2 M 2 Y 2 Y b σ + σ = σ , would be greater. 2. CAPM assumes that company-specific risk will be eliminated in a portfolio, so the risk premium under the CAPM would not be affected. d. 1. The stock's variance would not change, but the risk of the stock to an investor holding a diversified portfolio would be greatly reduced. 2. It would now have a negative correlation with r M . 3. Because of a relative scarcity of such stocks and the beneficial net effect on portfolios that include it, its "risk premium" is likely to be very low or even negative. Theoretically, it should be negative. 45 30 15 -15 -30 -15 15 30 45 r S (%) r M (%)
Image of page 6
Chapter 5: 5 - 7 5-3 a. . ) r r ( r b ) r r ( r r M i iM RF M RF i RF M RF i σ σ ρ + = + = b. CML: . r r r r p M RF M RF p σ σ + = SML: . r r r r r i iM M RF M RF i σ σ + = With some arranging, the similarities between the CML and SML are obvious. When in this form, both have the same market price of risk, or slope,(r M - r RF )/ σ M . The measure of risk in the CML is σ p . Since the CML applies only to efficient portfolios, σ p not only represents the portfolio's total risk, but also its market risk. However, the SML applies to all portfolios and individual securities. Thus, the appropriate risk measure is not σ i , the total risk, but the market risk, which in this form of the SML is r iM σ i , and is less than for all assets except those which are perfectly positively correlated with the market, and hence have r iM = +1.0. 5-4 a. Using the CAPM: r i = r RF + (r M - r RF )b i = 7% + (1.1)(6.5%) = 14.5% b. Using the 3-factor model: r i = r RF + (r M – r rf )b i + (r SMB )c i + (r HML )d i = 7% + (1.1)(6.5%) + (5%)(0.7) + (4%)(-0.3) = 16.45%
Image of page 7

You've reached the end of your free preview.

Want to read all 7 pages?

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Stuck? We have tutors online 24/7 who can help you get unstuck.
A+ icon
Ask Expert Tutors You can ask You can ask You can ask (will expire )
Answers in as fast as 15 minutes