You are given the following two equations:SML: E(Ri) = Rf + (E(RM) − Rf )βi (1)CML: E(Rp) = Rf +E(RM) − RfσMσp (2)You also have the following information: E(RM) = .15, Rf = .06, σM = .15. Answerthe following questions, assuming that the capital asset pricing model is correct:(a) Which equation would you use to determine the expected return on an individualsecurity with a standard deviation of returns σ = .5 and a β = 2? Given theparameters above, what is the expected return for that security?(b) Which equation would you use to determine the expected return on a portfolioknowing that it is an efficient portfolio (consisting of the market portfolio Mcombined with the risk-free rate)? If you were told that the standard deviationof returns on that efficient portfolio is equal to σM and you were given the aboveparameters, what is the expected return on that portfolio?(c) Can you determine the β of the portfolio in (b)?(d) Given your answers above, expand on what type of risky assets equation (1) canbe used for, and what type of risky assets equation (2) can be used for.
You are given the following two equations:
SML: E(Ri) = Rf + (E(RM) − Rf )βi (1)
CML: E(Rp) = Rf +
E(RM) − Rf
σM
σp (2)
You also have the following information: E(RM) = .15, Rf = .06, σM = .15. Answer
the following questions, assuming that the
(a) Which equation would you use to determine the expected return on an individual
security with a standard deviation of returns σ = .5 and a β = 2? Given the
parameters above, what is the expected return for that security?
(b) Which equation would you use to determine the expected return on a portfolio
knowing that it is an efficient portfolio (consisting of the market portfolio M
combined with the risk-free rate)? If you were told that the standard deviation
of returns on that efficient portfolio is equal to σM and you were given the above
parameters, what is the expected return on that portfolio?
(c) Can you determine the β of the portfolio in (b)?
(d) Given your answers above, expand on what type of risky assets equation (1) can
be used for, and what type of risky assets equation (2) can be used for.
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