Plot the Security Market Line (SML) Superimpose the CAPM’s required return on the SML Indicate which investments will plot on, above and below the SML? 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.
Plot the Security Market Line (SML) Superimpose the CAPM’s required return on the SML Indicate which investments will plot on, above and below the SML? 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.
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
Using the data generated in the attached picture:
- Plot the Security Market Line (SML)
- Superimpose the CAPM’s required return on the SML
- Indicate which investments will plot on, above and below the SML?
- 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.
Transcribed Image Text:State of the Economy
Recession
Below Average
Average
Above Average
Boom
Mean
Variance
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 T-Bills
0.2
0.1
0.3
0.3
0.1
7
7
7
7
7
7
ooo의
0
0
0
0
이기
0
7
% Return on T-Bills, Stocks and Market Index
Phillips
Pay-up
-22
-2
20
35
50
16.9
5.5
23.4
0.32
0.04
0.9953
1.32
17.54
28
14.7
0
-10
-20
2.07
2.4
15.6
1.18
-0.03
-0.9953
-0.88
-0.02
Rubber-made Market Index
-13
10
-10
7
45
30
19.6
3.6
18.9
0.18
0.02
0.6894
0.74
12.89
1
15
29
43
15
3.1
17.7
0.21
0.03
Defensive
1
1
15
Overvalued Undervalued Undervalued Fairly priced
Aggressive Defensive Defensive
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