Chapter 11, Problem 26QP

Summary Introduction

To determine: The ratios of betas are equal to the ratios of risk premiums of the two assets of the portfolio.

Introduction:

Capital asset pricing model (CAPM) is an equation derived from the security market line that attempts to explain the relationship between the risky asset’s expected return and its beta coefficient. The formula to calculate the expected return using CAPM is as follows:

$E(R_i)=R_f+\left[E(R_M)-R_f\right]\times {\beta }_i$

E (R_i) refers to the expected return on a risky asset

R_f refers to the risk-free rate

E (R_M) refers to the expected return on the market portfolio

β_i refers to the beta coefficient of the risky asset relative to the market portfolio

Expected return is the return that the investors expect on a risky investment in the future.