Capital asset pricing model (CAPM) is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital. It is simple and allows for easy comparisons of investment alternatives. However, it is not without its shortcomings. Required: Critically discuss the shortcomings of CAPM Adeline approaches you for advice on the following portfolio that she is holding. She expects a risk-free return (RFR) of 4% and market return (RM) of 8%. Stock Beta b Current Price (RM) Expected Price (RM) Expected Dividend (RM) A 0.85 26 27 0.50 B 1.25 32 34 1.50 C -0.20 37 38 Nil Required: Calculate the required returns for stocks A, B, and C respectively. 2. Calculate the expected returns for stocks A, B, and C respectively. 3. Comment on whether stocks A, B and C are overvalued or undervalued. Then advise Adeline on the appropriate actions to be undertaken accordingly.
Capital asset pricing model (CAPM) is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital. It is simple and allows for easy comparisons of investment alternatives. However, it is not without its shortcomings. Required: Critically discuss the shortcomings of CAPM Adeline approaches you for advice on the following portfolio that she is holding. She expects a risk-free return (RFR) of 4% and market return (RM) of 8%. Stock Beta b Current Price (RM) Expected Price (RM) Expected Dividend (RM) A 0.85 26 27 0.50 B 1.25 32 34 1.50 C -0.20 37 38 Nil Required: Calculate the required returns for stocks A, B, and C respectively. 2. Calculate the expected returns for stocks A, B, and C respectively. 3. Comment on whether stocks A, B and C are overvalued or undervalued. Then advise Adeline on the appropriate actions to be undertaken accordingly.
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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Capital asset pricing model (CAPM) is widely used throughout finance for pricing risky securities and generating expectedreturns for assets given the risk of those assets and cost of capital. It is simple and allows for easy comparisons of investment alternatives. However, it is not without its shortcomings.
Required: Critically discuss the shortcomings of CAPM
- Adeline approaches you for advice on the following portfolio that she is holding. She expects a risk-free return (RFR) of 4% and market return (RM) of 8%.
|
Stock |
Beta b |
Current Price (RM) |
Expected Price (RM) |
Expected Dividend (RM) |
|
A |
0.85 |
26 |
27 |
0.50 |
|
B |
1.25 |
32 |
34 |
1.50 |
|
C |
-0.20 |
37 |
38 |
Nil |
Required:
- Calculate the required returns for stocks A, B, and C respectively.
2. Calculate the expected returns for stocks A, B, and C respectively.
3. Comment on whether stocks A, B and C are overvalued or undervalued. Then advise Adeline on the appropriate actions to be undertaken accordingly.
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