1. A security has an expected rate of return of 0.11 and has a beta (B) of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. Show whether this security is underpriced, fairly priced or overpriced.
1. A security has an expected rate of return of 0.11 and has a beta (B) of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. Show whether this security is underpriced, fairly priced or overpriced.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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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
Transcribed Image Text:A security has an expected rate of return of 0.11 and has a beta (B) of 1.5. The
risk-free rate is 0.05 and the market expected rate of return is 0.09. Show
whether this security is underpriced, fairly priced or overpriced.
1.
The returns on share A follow the market model with coefficients aa = 0.01, Ba =
1.25. If at time t, K MT = 0.02 and the actual return on share A is 0.025, calculate
EAt (the error term).
2.
3.
An investor invests 30 percent of his wealth in a risky asset with an expected rate
of return of 0.15 and a variance of 0.04 and 70 percent in a risk-free asset with a
return of 0.06. Calculate the portfolio's expected return.
4.
Toyota stock has the following probability distribution of expected prices one year
from now:
State Probability Price
1
25%
40%
£50
2
£60
3
35%
£70
Currently, each share is priced at £55. Toyota will pay a dividend of £4 per share
at the end of the year. What is your expected holding-period return on Toyota?
5.
According to the Capital Asset Pricing Model (CAPM), what does beta measure?
Explain briefly.
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