Consider the following information about the various states of economy and the returns of various investment alternatives for each scenario. Answer the questions that follow. State of the Economy Recession Below Average Average Above Average Boom Mean Standard Deviation Coefficient of Variation Covariance with MP Correlation with Market Index Beta CAPM Req. Return Valuation (Overvalued/Undervalued/Fairly Valued) Nature of stock (Aggressive/Defensive) Probability 0.2 0.1 0.3 0.3 0.1 % Return on T-Bills, Stocks and Market Index Pay- Rubber- Market made Index 10 -13 1 15 29 43 T- Bills 7 7 7 7 7 Phillips -22 -2 20 35 50 up 28 14.7 -10 0 7 -10 -20 45 30
Consider the following information about the various states of economy and the returns of various investment alternatives for each scenario. Answer the questions that follow. State of the Economy Recession Below Average Average Above Average Boom Mean Standard Deviation Coefficient of Variation Covariance with MP Correlation with Market Index Beta CAPM Req. Return Valuation (Overvalued/Undervalued/Fairly Valued) Nature of stock (Aggressive/Defensive) Probability 0.2 0.1 0.3 0.3 0.1 % Return on T-Bills, Stocks and Market Index Pay- Rubber- Market made Index 10 -13 1 15 29 43 T- Bills 7 7 7 7 7 Phillips -22 -2 20 35 50 up 28 14.7 -10 0 7 -10 -20 45 30
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
Related questions
Concept explainers
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.
Question
Transcribed Image Text:Consider the following information about the various states of economy and the returns
of various investment alternatives for each scenario. Answer the questions that follow.
State of the Economy
Recession
Below Average
Average
Above Average
Boom
Mean
Standard Deviation
Coefficient of Variation
Covariance with MP
Correlation with Market Index
Beta
CAPM Req. Return
Valuation
(Overvalued/Undervalued/Fairly
Valued)
Nature of stock
(Aggressive/Defensive)
Probability
0.2
0.1
0.3
0.3
0.1
Question 2
% Return on T-Bills, Stocks and Market
Index
Pay- Rubber- Market
made
Index
10
-13
T-
Bills
7
7
7
7
7
Phillips
-22
-2
20
35
50
up
28
14.7
0
-10
-20
Question 1
Fill the parts in the above table that are shaded in yellow. You will notice that there are
nine line items.
Using the data generated in the previous question (Question 1);
a) Plot the Security Market Line (SML)
-10
7
45
30
1
15
29
43
b) Superimpose the CAPM's required return on the SML
c) Indicate which investments will plot on, above and below the SML?
d) If an investment's expected return (mean return) does not plot on the SML, what does
it show? Identify undervalued/overvalued investments from the graph.
Question 3
From the information generated in the previous two questions;
a) Identify two investment alternatives that can be combined in a portfolio. Assume a
5050 investment allocation in each investment alternative
b) Compute the expected return of the portfolio thus formed
c) Compute the portfolio's beta. Is the portfolio aggressive or defensive?
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