Calculate the expected rate of return on this risk-free portfolio? (Hint: Can a particular stock portfolio be substituted for the risk-free asset?
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.
Suppose that many stocks are traded in the market and that it is possible to borrow at the risk-free rate, rƒ. The characteristics of two of the stocks are as follows:
| Stock | Expected Return | Standard Deviation | ||||
| A | 5 | % | 20 | % | ||
| B | 8 | % | 80 | % | ||
| Correlation = –1 | ||||||
a. Calculate the expected
b. Could the equilibrium rƒ be greater than 5.60%?
multiple choice
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Yes
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No
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