1. Suppose the risk free rate is 3%. The expected and the standard deviation of the return of the market portfolio are 10 % and 15%. Stock A has a standard deviation of return of 10%. The correlation coefficient between the returns of stock A and of the market is 0.6. A. What is the beta of stock A? B. According to CAPM, what is the expected return of stock A? C. If the actual expected return is 10%, is the stock over- or under-valued?
1. Suppose the risk free rate is 3%. The expected and the standard deviation of the return of the market portfolio are 10 % and 15%. Stock A has a standard deviation of return of 10%. The correlation coefficient between the returns of stock A and of the market is 0.6. A. What is the beta of stock A? B. According to CAPM, what is the expected return of stock A? C. If the actual expected return is 10%, is the stock over- or under-valued?
Chapter8: Analysis Of Risk And Return
Section: Chapter Questions
Problem 12P
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Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
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Transcribed Image Text:1. Suppose the risk free rate is 3%. The expected and the standard deviation of the return of the
market portfolio are 10% and 15%. Stock A has a standard deviation of return of 10%. The
correlation coefficient between the returns of stock A and of the market is 0.6.
A. What is the beta of stock A?
B. According to CAPM, what is the expected return of stock A?
C. If the actual expected return is 10%, is the stock over- or under-valued?
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