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Tutorial 9 Questions

The document contains 9 questions related to the Capital Asset Pricing Model (CAPM): 1. If the standard deviation of the market portfolio increases by 50%, the CAPM implies Google's required rate of return would also increase. 2. If we can identify a portfolio with a higher Sharpe ratio than the S&P 500, we should not reject the single-index CAPM. 3. Stocks with beta of zero have an expected return of zero. The CAPM implies higher returns are required for more volatile securities. A portfolio with beta of 0.75 can be constructed by investing 0.75 in bonds and the remainder in stocks.

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Amber Yi Woon Ng
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54 views

Tutorial 9 Questions

The document contains 9 questions related to the Capital Asset Pricing Model (CAPM): 1. If the standard deviation of the market portfolio increases by 50%, the CAPM implies Google's required rate of return would also increase. 2. If we can identify a portfolio with a higher Sharpe ratio than the S&P 500, we should not reject the single-index CAPM. 3. Stocks with beta of zero have an expected return of zero. The CAPM implies higher returns are required for more volatile securities. A portfolio with beta of 0.75 can be constructed by investing 0.75 in bonds and the remainder in stocks.

Uploaded by

Amber Yi Woon Ng
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Tutorial 9 Questions

1. Suppose investors believe that the standard deviation of the market-index portfolio has
increased by 50%. What does the CAPM imply about the effect of this change on the
required rate of return on Google’s investment projects ?
2. Consider the statement: “If we can identify a portfolio with a higher Sharpe ratio than
the S&P 500 Index portfolio, then we should reject the single-index CAPM.” Do you
agree or disagree ? Explain.
3. Are the following true or false ? Explain.
(a) Stocks with a beta of zero offer an expected rate of return of zero.
(b) The CAPM implies that investors require a higher return to hold highly volatile
securities.
(c) You can construct a portfolio with a beta of 0.75 by investing 0.75 of the
investment budget in government bonds and the remainder in the market
portfolio.
4. Here are data on 2 companies. The rate of government bond is 4% and the market risk
premium is 6%.

Company $1 Discount Store Everything $5


Forecast return 12% 11%
Standard deviation of 6% 10%
returns
Beta 1.5 1.0

What should be the expected rate of return for each company, according to the capital
asset pricing model (CAPM) ?
5. Characterise each company in the previous problem as underpriced, overpriced or
properly priced.
6. What is the expected rate of return for a stock that has a beta of 1 if the expected return
on the market is 15% ?
(a) 15%
(b) More than 15%
(c) Cannot be determined without the risk-free rate.

7. Kaskin Inc. stock has a beta of 1.2 and Quim Inc. stock has a beta of 0.6. Which of the
following statements is most accurate ?
(a) The equilibrium expected rate of return is higher for Kaskin than for Quinn.
(b) The stock of Kaskin has higher volatility than Quinn.
(c) The stock of Quinn has more systematic risk than that of Kaskin.

8. What must be the beta of a portfolio with E(rp) = 20%, if rf = 5% and E(rm) = 15% ?
9. The market price of a security is $40. Its expected rate of return is 13%. The risk-free
rate is 7%, and the market risk premium is 8%. What will the market price of the
security be if its beta doubles (and all other variables remain unchanged)? Assume the
stock is expected to pay a constant dividend in perpetuity.

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