A client of ZBX Financial Planning is considering a shift in her portfolio holdings. Given recent stock market declines she is considering a weight of 75% in QQQ (a Nasdaq index) and the remainder in AGG (a corp bond index). Currently the beta of QQQ is 2.0 and the beta of AGG is 0.6, the overall market index has an expected return of 12%, and the risk-free rate is 4%. (i) What will be the E(R) of the client's portfolio according to the CAPM? (ii) Above we used the CAPM to estimate an expected return of a portfolio. How can the CAPM be useful for the estimation of an investment's NPV?
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.
A client of ZBX Financial Planning is considering a shift in her portfolio holdings. Given recent stock market declines she is considering a weight of 75% in QQQ (a Nasdaq index) and the remainder in AGG (a corp bond index). Currently the beta of QQQ is 2.0 and the beta of AGG is 0.6, the overall market index has an expected return of 12%, and the risk-free rate is 4%.
(i) What will be the E(R) of the client's portfolio according to the CAPM?
(ii) Above we used the CAPM to estimate an expected return of a portfolio. How can the CAPM be useful for the estimation of an investment's NPV?
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