Question

please answer question 4

Examples on Asset Pricing Models 1. You are given the following equilibrium expected returns and risks -07: 12 ke (RA) - 12.296; E(R) -15.556; No. 0. 015 a. What is the equation of the Security Market Line? b. A portfolio, made up of A (above) and another security, has a beta of 1.10 and expected return of 1396Which one would you rather buy - A alone or the portfolio? Why? ES 1.6 I OVAL B A c. Given the SML above, what is the maximum you will be willing to pay today for a stock that has a beta of 0.6, if the expected price next year is $48 and it is expected to pay dividends of $1.00 per share? ). 1.6 1997 d. If investors become more risk averse, will the expected return for B be higher or lower than 15.5%? HIGH 2. You are given the following information from a market in equilibrium: E(RA) - 15.6%; E(Ra) - 12.4%; BA-12: Do - 0.8 a. What is the equation of the Security Market Line based on the CAPM? (M b. What is the equilibrium expected return on a portfolio created from 45% A and 55% B. 13.34 c. The estimated expected on a stock C is 14%. If the beta of C is 1.3, is C overvalued or undervalued? Eithe) 1.6 7 .7 Auto d. Suppose the risk-free rate goes up by 1% (100 basis points), what will be the new expected return for A? ECF12 ... . . . e. If the expected return on the market goes up by 156 (100 basis points) what will be the new expected return for A? ElRida aos (also.t) 0.06+ooqßi € (fe) = 131 3. Suppose asset returns follow a 2-factor APT and you are given the following equilibrium expected rates of return; Security i b E(R) 6.69 12.75% 19.9% bul 0.2 0.3 -0.2 s 0.1 0.5 0.6 b. What is the equation of the APT? (.06..075.09). CRC) 0.66 +. What is the expected return on a portfolio of B and C with zero sensitivity 2 to factor 1? +0.4 - 6 )...06..61 . Suppose there is a security, D, with sensitivity of zero to factor 1, and 0.2 to factor 2, and expected return of 9.675%, will you buy it? Why? (1 ) An investor believes that the expected returns above (table) come from the CAPM instead of the APT but agrees with the risk-free rate estimated above. The analyst uses security B to demonstrate his point. What is his estimate of the market portfolio assuming the beta of B is 0.8? m 14-4 4. Suppose asset returns follow a 2-factor APT and you are given the following equilibrium rates of return: Stock i E(R) bi b i C 0.208 0.7 1.1 D 0.145 -0. 2 1 1.1 E 0.216 1.2 0.8 . a. What is the equation of the APTEM -16 .07 8 b. Suppose there is portfolio, P, with observed expected return of 15.6%. P has sensitivity of 1.32 to factor 1 and zero sensitivity to factor 2. ISP undervalued or overvalued?

Answer 1

@ Rc = R6 + 0.7XRE & 1.1XR2 = 0.208 Ro= Rp + (-0.2)+R + 1.1 XR2 = Oilus RE = Rf it 1.2xR, & 0.8XR2 = 0.216. ! egn (11) - eqh (1) Rc- Ro = (Rp Rp ) + (0.7+0:2) ķ +(1.1-1.) R2 = 0.268 -0.145 7 0.9R, = 0.063 & R = 0.07

eeqh (1u) - egna) R - RR ) +(1.2 - 0.7k, + (0.8-1.) R2 50-216-0208 0.5 0.7 -0.3 R2 = or 008 & -0.3R2 = 0.008 - 0.035 5 - 0 3 R2 = -0.007 pulting the value of R& R2 En eq^o) Rp = 0.208 -0.7 X 007 - Xoog = 0.06 so con of the APT Ri= 0.06 + 0.07-ß + o.og ß2 (5) Bin 132 and B2 - 0 006 + 007 31.32 0 0.152 so Rp = 15.2 %. Observed expected Return = 15.6% So the portfolio P is undervalued here,