Consider the following information about the various states of economy and the returns of various investment alternatives for each scenario. Answer the questions that follow. % Return on T-Bills, Stocks and Market Index State of the Economy Probability TBills Phillips Payup Rubbermade Market Index Recession 0.2 7 -22 28 10 -13 Below Average 0.1 7 -2 14.7 -10 1 Average 0.3 7 20 0 7 15 Above Average 0.3 7 35 -10 45 29 Boom 0.1 7 50 -20 30 43 Mean Standard Deviation Coefficient of Variation Covariance with MP Correlation with Market Index Beta CAPM Req. Return Valuation (Overvalued/Undervalued/Fairly Valued) Nature of stock (Aggressive/Defensive) Question 1 Fill the parts in the above table that are shaded in yellow. You will notice that there are nine line items. Question 2 Using the data generated in the previous question (Question 1); a) Plot the Security Market Line (SML) b) Superimpose the CAPM’s required return on the SML c) Indicate which investments will plot on, above and below the SML? d) If an investment’s expected return (mean return) does not plot on the SML, what does it show? Identify undervalued/overvalued investments from the graph
Consider the following information about the various states of economy and the returns of
various investment alternatives for each scenario. Answer the questions that follow.
% Return on T-Bills, Stocks and Market
Index
State of the Economy Probability TBills Phillips Payup
Rubbermade
Market
Index
Recession 0.2 7 -22 28 10 -13
Below Average 0.1 7 -2 14.7 -10 1
Average 0.3 7 20 0 7 15
Above Average 0.3 7 35 -10 45 29
Boom 0.1 7 50 -20 30 43
Mean
Standard Deviation
Coefficient of Variation
Covariance with MP
Correlation with Market Index
Beta
CAPM Req. Return
Valuation
(Overvalued/Undervalued/Fairly
Valued)
Nature of stock
(Aggressive/Defensive)
Question 1
Fill the parts in the above table that are shaded in yellow. You will notice that there are nine
line items.
Question 2
Using the data generated in the previous question (Question 1);
a) Plot the Security Market Line (SML)
b) Superimpose the
c) Indicate which investments will plot on, above and below the SML?
d) If an investment’s expected return (mean return) does not plot on the SML, what does
it show? Identify undervalued/overvalued investments from the graph
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