Concept explainers
a.
To determine: Whether the market portfolio is still efficient.
Introduction: CAPM is abbreviated as
b.
To determine: The stocks with buying opportunities and the stocks with selling opportunities.
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Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
- Suppose the solid line represents the capital market line that results from a CAPM equilibrium and the dotted curves represent indifference curves for a given individual. Which of the following is correct if point M corresponds to the market portfolio? Group of answer choices The individual optimally holds only the market portfolio, M. The individual optimally holds portfolio B which can be partially characterized by a long position in the riskless asset. The individual optimally holds portfolio B which can be partially characterized by a short position in the riskless security The individual optimally holds portfolio A which can be partially characterized by a long position in the riskless security. None of the above.arrow_forwardWhich of the following statements is CORRECT? (Assume that the risk-free rate is a constant.) a. The effect of a change in the market risk premium depends on the slope of the yield curve. b. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. c. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0. d. The effect of a change in the market risk premium depends on the level of the risk-free rate. e. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.arrow_forwardAssume that the CAPM assumptions hold. Consider the following statements:i. A stock with a beta below zero will tend to move in the same direction as the market but will tend to move less aggressively in that direction than the market does.ii. Alpha measures the additional risk we take on top of the risk of the market portfolio.arrow_forward
- Which of the following is TRUE? To construct a capital market line, we use expected return as y-axis and beta as x-axis On the capital market line debt securities are located to the right of the market portfolio To construct a security market line, we use expected return as y-axis and beta as x-axis Market portfolio lays at an intersection of the average indifference curve of a risk-averse investor and the efficient portfolioarrow_forwardVolatility smile” is referred to as evidence against the Black-Scholes model. Why is that? A) Black-Scholes model assumes that different options on a given stock have different values for implied volatility b.) Volatility of returns on one and the same stock, over one and the same future period of time, can only take one value C) Black-Scholes model generates option premium close to the observed premium if the observed stock volatility is usedarrow_forwardGiven the information in the table below, which of the following statements is correct, assuming that either security will be held in a portfolio with other investments? Stock Expected Return Required Return Beta Standard Deviation A 10% 12% 0.9 25% B 8% 5% 0.3 35% Question 26 options: The investor should purchase both stocks because their beta is less than that of the market. The investor should purchase A since its risk, as measured by standard deviation, is the lowest. The investor should purchase A because it requires the highest rate of return. The investor should purchase B since its expected return exceeds its required return.arrow_forward
- 1. What are the recommended options strategies when you expect the market has extreme (high) volatility?arrow_forwardConsider the following two scenarios for the economy and the expected returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D. Scenario Rate of Return Market Aggressive Stock A Defensive Stock D Bust −8% −10% −6% Boom 32 38 24 Required: Find the beta of each stock. If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock. If the T-bill rate is 4%, what does the CAPM say about the fair expected rate of return on the two stocks? Which stock seems to be a better buy on the basis of your answers to (a) through (c)?arrow_forwardThe security market line (SML) is an equation that shows the relationship between risk as measured by beta and the required rates of return on individual securities. The SML equation is given below: If a stock's expected return plots on or above the SML, then the stock's return is sufficient to compensate the investor for risk. If a stock's expected return plots below the SML, the stock's return is insufficient to compensate the investor for risk.The SML line can change due to expected inflation and risk aversion. If inflation changes, then the SML plotted on a graph will shift up or down parallel to the old SML. If risk aversion changes, then the SML plotted on a graph will rotate up or down becoming more or less steep if investors become more or less risk averse. A firm can influence market risk (hence its beta coefficient) through changes in the composition of its assets and through changes in the amount of debt it uses. Quantitative Problem: You are given the following…arrow_forward
- Which one of the following expressions about risk and returns is wrong? A. In general, one reason why a stock is riskier than a bond is that because cash flows from a bond are known and promised, whereas cash flows from a stock are neither known nor promised. B. According to CAPM model, a well-diversified portfolio will have a beta which equals to 0. C. Risk premium is the extra return provided on risky assets to compensate for risk. The difference between risky return and the risk-free return. D. Unexpected return happened because new information came to light which caused our expectations about prices and returns to change.arrow_forwardAccording to the Black-Scholes formula, what will be the hedge ratio (delta) of a call option as the stock price becomes infinitely large? Explain briefly.arrow_forwardConsider the following two scenarios for the economy and the expected returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D. Rate of Return Scenario Market AggressiveStock A DefensiveStock D Bust –8 % –13 % –6 % Boom 26 35 19 Required:a. Find the beta of each stock.b. If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock.c. If the T-bill rate is 5%, what does the CAPM say about the fair expected rate of return on the two stocks?d. Which stock seems to be a better buy on the basis of your answers to (a) through (c)?arrow_forward
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