EBK CORPORATE FINANCE
4th Edition
ISBN: 8220103145947
Author: DeMarzo
Publisher: PEARSON
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Textbook Question
Chapter 13, Problem 21P
In Problem 20, assume the risk-free rate is 3% and the market risk premium is 7%.
- a. What does the
CAPM predict the expected return for each stock should be? - b. Clearly, the CAPM predictions are not equal to the actual expected returns, so the CAPM does not hold. You decide to investigate this further. To see what kind of mistakes the CAPM is making, you decide to regress the actual expected return onto the expected return predicted by the CAPM.49 What is the intercept and slope coefficient of this regression? 49The Excel function SLOPE will produce the desired answers.
- c. What are the residuals of the regression in (b)? That is, for each stock compute the difference between the actual expected return and the best fitting line given by the intercept and slope coefficient in (b).
- d. What is the sign of the correlation between the residuals you calculated in (b) and market capitalization?
- e. What can you conclude from your answers to part b of the previous problem and part d of this problem about the relation between firm size (market capitalization) and returns? (The results do not depend on the particular numbers in this problem. You are welcome to verify this for yourself by redoing the problems with another value for the market risk premium, and by picking the stock betas and market capitalizations randomly.50)
50 The Excel command RAND will produce a random number between 0 and 1.
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Students have asked these similar questions
Based on the CAPM model, a stock with a negative beta has which of the following characteristics?
A. An expected return less than zero.
B. An expected return equal to the risk-free rate.
C. Since these are so rare, the CAPM model does not account for negative beta stocks.
D. An expected return less than the risk-free rate.
Hello
The first question is to how to the formula used in this problem. This is a question that you have previously answered, but i dont understand how we can use R squarred to find the standard Deviation.
The second question is about Beta squarred multiplied with the SD squarred for the market index. What does this mean specifically, i have understood this as being the Systematic Risk? but what else is it used for
6. Which of the following statements is incorrect?
A. The expected risk premium on each investment is proportional to its beta.
B. Securities with a higher market risk require a higher expected return.
C. The stock beta measures the sensitivity of a stock's return to the return on
the market portfolio.
D. If the correlation of the stock returns in your stock portfolio increases over
time, then the variance of the portfolio return will decrease over time.
E. None of the above
7. Which of the following correctly ranks the various asset classes in the United
States according to their historical average risk premium (i.e. from low to high risk
premium)?
A. S&P 500 < long term government bonds < Treasury bills < small firms <
corporate bonds
B. Treasury bills < corporate bonds < long term government bonds < small
firms < S&P 500
C. Treasury Bills < long term government bonds < corporate bonds < S&P
500 < small firms
D. Long term government bonds < Treasury bills < corporate bonds < S&P
500…
Chapter 13 Solutions
EBK CORPORATE FINANCE
Ch. 13.1 - If investors attempt to buy a stock with a...Ch. 13.1 - What is the consequence of investors exploiting...Ch. 13.2 - How can an uninformed or unskilled investor...Ch. 13.2 - Under what conditions will it be possible to earn...Ch. 13.3 - Do investors hold well-diversified portfolios?Ch. 13.3 - Why is the high trading volume observed in markets...Ch. 13.3 - What must be true about the behavior of small,...Ch. 13.4 - What are several systematic behavioral biases that...Ch. 13.4 - Prob. 2CCCh. 13.5 - Prob. 1CC
Ch. 13.5 - Prob. 2CCCh. 13.6 - Prob. 1CCCh. 13.6 - Prob. 2CCCh. 13.7 - Prob. 1CCCh. 13.7 - How can you use the Fama-French-Carhart factor...Ch. 13.8 - Which is the most popular method used by...Ch. 13.8 - Prob. 2CCCh. 13.8 - Prob. 3CCCh. 13 - Assume that all investors have the same...Ch. 13 - Assume that the CAPM is a good description of...Ch. 13 - Prob. 3PCh. 13 - Prob. 4PCh. 13 - Prob. 5PCh. 13 - Explain what the following sentence means: The...Ch. 13 - You are trading in a market in which you know...Ch. 13 - Prob. 8PCh. 13 - Your brother Joe is a surgeon who suffers badly...Ch. 13 - Prob. 11PCh. 13 - Suppose that all investors have the disposition...Ch. 13 - Prob. 14PCh. 13 - Prob. 15PCh. 13 - Prob. 16PCh. 13 - Prob. 17PCh. 13 - Prob. 18PCh. 13 - Each of the six firms in the table below is...Ch. 13 - Prob. 20PCh. 13 - In Problem 20, assume the risk-free rate is 3% and...Ch. 13 - Prob. 22PCh. 13 - Prob. 23PCh. 13 - Prob. 24PCh. 13 - Explain why if some investors are subject to...Ch. 13 - Prob. 26PCh. 13 - Prob. 27PCh. 13 - You are currently considering an investment in a...Ch. 13 - Prob. 29P
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Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
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- You have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: Suppose a risk-free asset has an expected return of 5%. By definition, its standard deviation is zero, and its correlation with any other asset is also zero. Using only Asset A and the risk-free asset, plot the attainable portfolios.arrow_forwardIf a stock's expected return plots on or above the SML, then the stock's return is SML, the stock's return is to compensate the investor for risk. cent to compensate the investor for risk. If a stock's expected return plots below the The SML line can change due to expected Inflation and risk aversion. If inflation changes, then the SML plotted on a graph will shift up or down parallel to the old SML. If risk aversion changes, then the SML plotted on a graph will rotate up or down becoming more or less steep if investors become more or less risk averse. A firm can influence market risk (hence its beta coefficient) through changes in the composition of its assets and through changes in the amount of debt it uses. Quantitative Problem: You are given the following information for Wine and Cork Enterprises (WCE): Tar 4%; 10 % ; RPM 6%, and beta - 1.1 What is WCE's required rate of return? Do not round intermediate calculations. Round your answer to two decimal places. -75 % If inflation…arrow_forwardWhich of the following statements is CORRECT? a. The slope of the Security Market Line is beta. b. Any stock with a negative beta must in theory have a negative required rate of return, provided rRF is positive. c. If a stock's beta doubles, its required rate of return must also double. d. If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative. e. If a stock has a beta of to 1.0, its required rate of return will be unaffected by changes in the market risk premium.arrow_forward
- Please first fill in the spaces in the following table by assigning probabilities foreach scenario and assigning returns for stocks A and B, depending on your own choice. (The useof same probabilities and return data by different students will be treated as a cheat attempt andwill be penalized severely). Then, solve the following questions.Scenario Probability RA (%) RB (%)RecessionNormalBoom a) What is the expected return for Stock A (E(RA))?b) What is the expected return for Stock B (E(RB))?c) What is the covariance between the returns of Stock A and B?arrow_forwardWhich of the following is true for testing stock price predictability? Select one: a. All of the options O b. When considering an RW without drift and the Cowles-Jones test, the probability of observing an increase or a decrease in price is no longer 0.5 O c. None of the options O d. The test statistic of the Volatility Ratio test is enough for us to be able to draw significant conclusions O e. The Box-Pierce g-test is based on the fact that for RW3 processes there should be no autocorrelation between the returnsarrow_forwardThe SML shows the return needed given risk as measured by beta. And there are situations where a stock might be mispriced relative to CAPM. Given the relationship with the security mark line (SML), if a stock is properly priced relative to CAPM , where would it plot on the graph relative to the SML? A. on the Y-axis B. on the security market line C. below the security market line D. above the security market linearrow_forward
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