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

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Beta 20 1.0 2.0 r(%) r X = 10.6% r RF = 8.6%
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 (%)
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%

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