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 Probability 0.2 0.1 % Return on T-Bills, Stocks and Market Index T- Bills 7 7 Phillips -22 -2 Pay- Rubber- made 10 up 28 14.7 -10 Market Index -13 1
Question 3
a) Identify two investment alternatives that can be combined in a portfolio. Assume a 50-
50 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?
![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
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
T-
Bills
7
7
7
7
7
Phillips
-22
-2
20
35
50
Pay- Rubber-
made
10
-10
7
45
30
up
28
14.7
0
-10
-20
Market
Index
-13
1
15
29
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can you explain why t-bill 7 % was used for calculating the CAPM return? I think it has something to do with % return on t-bill not sure
Can you provide the information used to plot the security market line in excel?
Plot the Security Market Line (SML)
b) Superimpose the
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 (
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