ESSENTIALS OF INVESTMENTS>LL<+CONNECT
11th Edition
ISBN: 9781264001026
Author: Bodie
Publisher: MCG
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Chapter 6, Problem 16PS
Assume expected returns and standard deviations for all securities, as well as the risk-free rate for lending and borrowing, are known. Will investors arrive at the same optimal risky portfolio? Explain. (LO 6-4)
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H2.
What are the different types of expected return and related risk, for individual assets and for portfolios as a whole. Explain carefully what each type represents and give examples in each case. What type of expected returns does the CAPM model capture? What type of expected return and risk you are exposed to if you have the FTSE 100 INDEX only in the portfolio?
The market portfolio (M) has the expected rate of return E(rM) = 0.12. Security A is traded in the market. We know that E(rA) = 0.17 and βA = 1.5.
(1) What is the rate of return of the risk-free asset (rf)?
(2) Security B is also traded in the market. βB = 0.8. Then what is “fair” expected rate of return of security B according to the CAPM?
(3) Security C is a third security traded in the market. βC = 0.6, and from the market price, investors calculate E(rC) = 0.1. Is C overpriced or underpriced? What is αC?
Which of the following is TRUE?
To construct a capital market line, we use expected return as y-axis and beta as x-axis
On the capital market line debt securities are located to the right of the market portfolio
To construct a security market line, we use expected return as y-axis and beta as x-axis
Market portfolio lays at an intersection of the average indifference curve of a risk-averse investor and the efficient portfolio
Chapter 6 Solutions
ESSENTIALS OF INVESTMENTS>LL<+CONNECT
Ch. 6.5 - Prob. 1EQCh. 6.5 - In light of each firm’s exposure to the financial...Ch. 6 - Prob. 1PSCh. 6 - When adding a risky asset to a portfolio of many...Ch. 6 - A portfolio’s expected return is 12%, its standard...Ch. 6 - An investor ponders various allocations to the...Ch. 6 - The standard deviation of the market-index...Ch. 6 - Suppose that the returns on the stock fund...Ch. 6 - Use the rate-of-return data for the stock and bond...Ch. 6 - Prob. 8PS
Ch. 6 - Prob. 9PSCh. 6 - Prob. 10PSCh. 6 - Prob. 11PSCh. 6 - Prob. 12PSCh. 6 - Stocks offer an expected rate of return of 10%...Ch. 6 - Suppose that many stocks are traded in the market...Ch. 6 - You can find a spreadsheet containing annual...Ch. 6 - Assume expected returns and standard deviations...Ch. 6 - Prob. 17PSCh. 6 - Prob. 18PSCh. 6 - A project has a 0.7 chance of doubling your...Ch. 6 - Investors expect the market rate of return this...Ch. 6 - The following figure shows plots of monthly rates...Ch. 6 - Prob. 22PSCh. 6 - Prob. 23PSCh. 6 - Prob. 25CCh. 6 - Prob. 1CPCh. 6 - Prob. 2CPCh. 6 - Abigail Grace has a $900,000 fully diversified...Ch. 6 - Prob. 4CPCh. 6 - Prob. 5CPCh. 6 - Prob. 6CPCh. 6 - Prob. 7CPCh. 6 - Prob. 1WMCh. 6 - Following the procedures in the previous question,...Ch. 6 - Prob. 3WMCh. 6 - Prob. 4WM
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- Define the real risk-free rate (r*). What security canbe used as an estimate of r*? What is the nominalrisk-free rate (rRF)? What securities can be used asestimates of rRF?arrow_forwardPortfolio theory tends to define risky investments in terms of just two factors: expectedreturns and variance (or standard deviation) of those expected returns. What assumptions need to be made about investors and the expected investment returns (one assumption in each case) to justify this ‘two-factor’ approach? Are these assumptions justified in real life?arrow_forwardneed correct and urgentarrow_forward
- As the number of stocks in a portfolio increase, the portfolio’s systematic risk can either increase or decrease. Select one: True Falsearrow_forwardThe security market line depicts: a. Expected return as a function of systematic risk (indicated by beta) b. The market portfolio as the optimal portfolio of risky assets c. The relationship between a security’s return and the return on the index d. Portfolio combinations of the market portfolio and the risk-free asset e. Expected return as a function of volatilityarrow_forwardA6) Finance In financial economic theory, an indifference curve shows: Select one: a. the one most desirable portfolio for a particular investor. b. the one most desirable market portfolio for all investors. c. all combinations of risk and expected return that are equally desirable to a particular investor. d. all combinations of portfolios that are equally efficient to all investors.arrow_forward
- In portfolio management, risk reduction is achieved by investing in a portfolio in which the securities Question 3 options:1) have a high covariance 2) have a high correlation coefficient 3) have a low coefficient of variation 4) have a lowcovariance 5) are perfectly positively correlated.arrow_forwardThe following figures show the optimal portfolio choice for two investors with different levels of risk-aversion graphically. Which statement is correct? E[R] 0.3 0.25 0.2 0.15 0.1 0.05 0 0 0.05 0.1 0.15 Figure 1 0.2 0.25 0.3 0.35 0.4 0.45 o (R) E[R] Figure (1) shows an investor with a conservative investment behavior. 0.3 0.25 0.2 0.15 0.1 0.05 0 0 Figure (2) shows an investor that borrows in risk-free rate and invests in the risky asset. 0.05 0.1 0.15 In the optimal point of both figures, the highest indifference curve is tangent to the efficient frontier. O In Figure (1), more aggressive investment decision led to a higher Sharpe ratio. Figure 2 0.2 0.25 o(R) 0.3 0.35 0.4 0.45arrow_forwardWhich of the following statements regarding the graph of the SML is most accurate? Select one O A. O B. B-1.0 The beta of Portfolios A, B, and C are identical as they fall directly on the line. The expected return of Portfolio C is the difference between the market's expected return and the risk-free rate. O C. Portfolio A has lower systematic risk than Portfolio B. OD. The slope of the line is the market risk premium.arrow_forward
- Question # 3. Markowitz theory indicates to create and construct a portfolio of assets to maximize returns within a given level of risk, or to devise one with a desired, specified and expected level of return with the least amount of risk. Under this broader concept, answer the followings: a) Justify, why an optimal portfolio should lie on security market line curvearrow_forwardWhich are the most efficient combination of securities that provides investors with maximum portfolio returns as portfolio risk increases?arrow_forwardsee attached image.arrow_forward
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