a) Consider these three stock returns with the following annualised characteristics: Stock A Stock B Stock C Expected Return Standard deviation 16% 10% 3% Stock A Stock B Stock C 26% 22% 11% According to the Capital Asset Pricing Model (CAPM), which stock is a better buy, when the market's expected return is 8%, and risk-free rate is 4%? What is the alpha of each stock? Plot the Security Market Line (SML) and each stock's risk-return point on one graph. Stock A 1 0.4 0.2 b) Now suppose that the same stock returns have the following correlation matrix: Beta Stock B 1.5 1.1 0.3 1 0.3 Stock C 1 Weights 55% 35% 10% If we form a three-stock portfolio by investing 55%, 35% and 10% in Stock A, B and C, respectively, what is the expected return and variance of this portfolio?

a) Consider these three stock returns with the following annualised characteristics: Stock A Stock B Stock C Expected Return Standard deviation 16% 10% 3% Stock A Stock B Stock C 26% 22% 11% According to the Capital Asset Pricing Model (CAPM), which stock is a better buy, when the market's expected return is 8%, and risk-free rate is 4%? What is the alpha of each stock? Plot the Security Market Line (SML) and each stock's risk-return point on one graph. Stock A 1 0.4 0.2 b) Now suppose that the same stock returns have the following correlation matrix: Beta Stock B 1.5 1.1 0.3 1 0.3 Stock C 1 Weights 55% 35% 10% If we form a three-stock portfolio by investing 55%, 35% and 10% in Stock A, B and C, respectively, what is the expected return and variance of this portfolio?

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

Stock Yields

The stock yield is otherwise known as the dividend yield. The dividend yield is an annual payment of the stock dividends to the holder of a firm’s stock. The dividend yield is a financial ratio to measure the value of dividend payout every year for the relative stock price. The yield of a stock is usually shown in a percentage that discloses the expected future earnings from stock depending on the current stock price in the future. Stock yield will change depending on the market fluctuations and in accordance with the market fluctuations, the dividends will be increased or decreased by the firm.

Question

a) Consider these three stock returns with the following annualised
characteristics:
Stock A
Stock B
Stock C
Expected Return
16%
10%
3%
Stock A
Stock B
Stock C
Standard
deviation
26%
22%
11%
Stock A
1
0.4
0.2
According to the Capital Asset Pricing Model (CAPM), which stock is a better
buy, when the market's expected return is 8%, and risk-free rate is 4%? What
is the alpha of each stock? Plot the Security Market Line (SML) and each
stock's risk-return point on one graph.
b) Now suppose that the same stock returns have the following correlation
matrix:
Beta
Stock B
1.5
1.1
0.3
1
0.3
Stock C
1
Weights
55%
35%
10%
If we form a three-stock portfolio by investing 55%, 35% and 10% in Stock A, B
and C, respectively, what is the expected return and variance of this portfolio?

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Step 1: Define Capital Asset Pricing Model.

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Step 2: Determine which stock is a better buy and each stock's alpha.

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Step 3: Plot the securities market line.

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Step 4: Determine the expected return of the portfolio given the weights of each stock.

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