INVESTMENTS (LOOSELEAF) W/CONNECT
11th Edition
ISBN: 9781260465945
Author: Bodie
Publisher: MCG
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Chapter 13, Problem 3PS
Summary Introduction
To state: Action M should consider to increase return on portfolio.
Introduction: The model that shows the relation between systematic risk and expected
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Consider the two (excess return) index model regression results for well-diversified portfolios A and B:
RAt = 0.02 + 1.0 × Rmt + eAt
RBt = 0.03 + 0.85 × Rmt + eBt
In addition, you know that the standard deviation of the index is 20%.
Calculate the covariance between the excess returns of portfolio A and B. Briefly discuss your results.
Assume that the risk-free rate, RF, is currently 8%, the market return, RM, is 12%, and asset A has a beta, of 1.10. (could be done on word document or excel).
Assume that as a result of recent economic events, inflationary expectations have declined by 3%, lowering RF and RM to 5% and 9%, respectively. Draw the new SML on the axes in part a, and calculate and show the new required return for asset A.
Assume that as a result of recent events, investors have become more risk averse, causing the market return to rise by 2%, to be14%. Ignoring the shift in part c, draw the new SML on the same set of axes that you used before, and calculate and show the new required return for asset A.
From the previous changes, what conclusions can be drawn about the impact of (1) decreased inflationary expectations and (2) increased risk aversion on the required returns of risky assets?
Consider the two (excess return) index model regression results for A and B.
RA= 0.9% + 1.1RM , R-square = 0.590, and Residual Standard Deviation = 11%
RB= -1.4% + 0.6RM, R-square = 0.456, and Residual Standard Deviation = 9.2%
Which stock has more firm-specific risk, market risk, and greater fraction of return variability for market movement? Also, if rf were constant at 4.4% and the regression had been run using total rather than excess returns, what would have been the regression intercept for stock A (write as percentage, rounded to 2 decimal places)?
Chapter 13 Solutions
INVESTMENTS (LOOSELEAF) W/CONNECT
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- You have observed the following returns over time: Assume that the risk-free rate is 6% and the market risk premium is 5%. What are the betas of Stocks X and Y? What are the required rates of return on Stocks X and Y? What is the required rate of return on a portfolio consisting of 80% of Stock X and 20% of Stock Y?arrow_forwardThe following table reports the percentage of stocks in a portfolio for nine quarters: a. Construct a time series plot. What type of pattern exists in the data? b. Use trial and error to find a value of the exponential smoothing coefficient that results in a relatively small MSE. c. Using the exponential smoothing model you developed in part (b), what is the forecast of the percentage of stocks in a typical portfolio for the second quarter of year 3?arrow_forwardAssume that the risk-free rate, RF, is currently 9% and that the market return, rm, is currently 16%. a. Calculate the market risk premium. b. Given the previous data, calculate the required return on asset A having a beta of 0.4 and asset B having a beta of 1.8.arrow_forward
- An analyst has modeled the stock of Crisp Trucking using a two-factor APTmodel. The risk-free rate is 6%, the expected return on the first factor (r1) is12%, and the expected return on the second factor (r2) is 8%. If bi1 5= 0.7 andbi2 5= 0.9, what is Crisp’s required return?arrow_forwardThe following table provides information relating to Omega Ltd, as well as the market portfolio. The risk-free rate of return is 3.4% . Asset Excess Return Variance Beta Omega 12% 0.021904 1.4 M 8.1% 0.010201 1 What is Omega's M2 value? a. 7.41% b. 11.59% c. 8.99% d. 9.27% What is Omega's Sharpe Ratio? a. 0.061 b. 0.811 c. 0.086 d. 0.581 please explain the calculation step by steparrow_forwardAccording to CAPM, the expected rate of return of a portfolio with a beta of 1.0 and an alpha of 0 is:a. Between rM and rf .b. The risk-free rate, rf .c. β(rM − rf).d. The expected return on the market, rM.arrow_forward
- Assume that the risk-free rate, RF, is currently 8%, the market return, RM, is 12%, and asset A has a beta, of 1.10. (could be done on word document or excel). Draw the security market line (SML) Use the CAPM to calculate the required return, on asset A. Assume that as a result of recent economic events, inflationary expectations have declined by 3%, lowering RF and RM to 5% and 9%, respectively. Draw the new SML on the axes in part a, and calculate and show the new required return for asset A. Assume that as a result of recent events, investors have become more risk averse, causing the market return to rise by 2%, to be14%. Ignoring the shift in part c, draw the new SML on the same set of axes that you used before, and calculate and show the new required return for asset A. From the previous changes, what conclusions can be drawn about the impact of (1) decreased inflationary expectations and (2) increased risk aversion on the required returns of risky assets?…arrow_forwardAssume that using the Security Market Line(SML) the required rate of return(RA)on stock A is found to be halfof the required return (RB) on stock B. The risk-free rate (Rf) is one-fourthof the required return on A. Return on market portfolio is denoted by RM. Find the ratioof betaof A(A) tobeta of B(B). Thank you for your help.arrow_forwardYou are given the following data: Risk-free rate is 4.1 percent, market return is 6.5 per cent, and market volatility is 12.2 per cent. The return of a portfolio is 11 per cent, its volatility is 15.2214 per cent, and its beta is 0.7. Calculate the measure called the Information ratio. A. 0.193 B. 0.414 C. 0.548 D. 4.500arrow_forward
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