Consider a world with only two risky assets, A and B, and a risk-free asset. The two risky assets are in equal supply in the market, i.e., the market portfolio M = 0.5A + 0.5B. It is known that R¯M = 11%, σA = 20%, σB = 40% and ρAB = 0.75. The risk-free rate is 2%. Assume CAPM holds. (a) What is the beta for each stock? (b) What are the values for R¯A and R¯B?
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. The two risky
assets are in equal supply in the market, i.e., the market portfolio M = 0.5A + 0.5B. It
is known that R¯M = 11%, σA = 20%, σB = 40% and ρAB = 0.75. The risk-free rate is
2%. Assume CAPM holds.
(a) What is the beta for each stock?
(b) What are the values for R¯A and R¯B?
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
