Suppose you group all the stocks in the world into mutually exclusive portfolios (each stock is in only one portfolio): growth stocks and value stocks. Suppose the two portfolios have equal size (in terms of total value), a correlation of 0.5, and the characteristics listed in the table. The risk free-rate is 2%. a. What is the expected return and volatility of the market portfolio (which is a 50–50 combination of the two portfolios)? b. Calculate the Sharpe ratios of the value stock, growth stock, and market portfolio. c. Does the CAPM hold in this economy? (Hint: Is the market portfolio efficient?)
Suppose you group all the stocks in the world into mutually exclusive portfolios (each stock is in only one portfolio): growth stocks and value stocks. Suppose the two portfolios have equal size (in terms of total value), a correlation of 0.5, and the characteristics listed in the table. The risk free-rate is 2%. a. What is the expected return and volatility of the market portfolio (which is a 50–50 combination of the two portfolios)? b. Calculate the Sharpe ratios of the value stock, growth stock, and market portfolio. c. Does the CAPM hold in this economy? (Hint: Is the market portfolio efficient?)
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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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
Suppose you group all the stocks in the world into mutually exclusive portfolios (each stock is in only one portfolio): growth stocks and value stocks. Suppose the two portfolios have equal size (in terms of total value), a correlation of 0.5, and the characteristics listed in the table. The risk free-rate is 2%.
a. What is the expected return and volatility of the market portfolio (which is a 50–50 combination of the two portfolios)?
b. Calculate the Sharpe ratios of the value stock, growth stock, and market portfolio.
c. Does the CAPM hold in this economy? (Hint: Is the market portfolio efficient ?)
Transcribed Image Text:Data table
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in order to copy its contents into a spreadsheet.)
Expected Return
14%
Volatility
10%
Value Stocks
Growth Stocks
20%
25%
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