Alice's portfolio consists solely of an investment in Merrill stock. Merrill has an expected return of 13% and a volatility of 18%. The market portfolio has an expected return of 12% and a volatility of 25%. The risk-free rate is 4%. Assume that the CAPM assumptions hold in the market.

Alice's portfolio consists solely of an investment in Merrill stock. Merrill has an expected return of 13% and a volatility of 18%. The market portfolio has an expected return of 12% and a volatility of 25%. The risk-free rate is 4%. Assume that the CAPM assumptions hold in the market.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 5P

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Concept explainers

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.

Question

Alice's portfolio consists solely of an investment in Merrill stock. Merrill has
an expected return of 13% and a volatility of 18%. The market portfolio has an
expected return of 12% and a volatility of 25%. The risk-free rate is 4%.
Assume that the CAPM assumptions hold in the market.
Assuming that Alice wants to maintain the current expected return on his
portfolio, then the amount that Alice should invest in the market portfolio to
minimize his volatility is closest to:
Select one:
O A. 110%
O B. 90%
C. 125%
D. 100%

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