Consider a world with only two risky assets, A and B, and a risk-free asset. Stock A has 200 shares outstanding, a price per share of $3.00, an expected return of 16% and a volatility of 30%. Stock B has 300 shares outstanding, a price per share of $4.00, an expected return of 10% and a volatility of 15%. The correlation coefficient ρAB = 0.4. Assume CAPM holds. (a) What is expected return of the market portfolio? (b) What is volatility of the market portfolio? (c) What is the beta of each stock?
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.
Consider a world with only two risky assets, A and B, and a risk-free asset. Stock A
has 200 shares outstanding, a price per share of $3.00, an expected return of 16% and
a volatility of 30%. Stock B has 300 shares outstanding, a price per share of $4.00, an
expected return of 10% and a volatility of 15%. The correlation coefficient ρAB = 0.4.
Assume
(a) What is expected return of the market portfolio?
(b) What is volatility of the market portfolio?
(c) What is the beta of each stock?
(d) What is the risk-free rate?
Trending now
This is a popular solution!
Step by step
Solved in 4 steps
