CONNECT WITH LEARNSMART FOR BODIE: ESSE
11th Edition
ISBN: 9781265046392
Author: Bodie
Publisher: MCG
expand_more
expand_more
format_list_bulleted
Videos
Textbook Question
Chapter 7, Problem 10CP
Assume that both X and Y are well-diversified port folios and the risk-free rate is 8%.
Portfolio Expected Return Beta
X 16% 100
Y 12 0 25
In this situation you could conclude that portfolios X and Y. (LO 7-4)
a. Are in equilibrium.
b. Offer an arbitrage opportunity.
c. Are both underpriced.
d. Are both fairly priced.
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Assume that there are two factors that price assets. Interest rate rf = 4%. You have thefollowing information about two well-diversified arbitrage-free risky portfolios.
(a) Calculate the risk premium of the two risk factors.
(b) There is a third well-diversified portfolio with β1 = 1.1 and β2 = 0.9. What is thisportfolio’s arbitrage free expected return?
(c) Suppose the forecasted return of the portfolio in the question (b) is 13.5%. Show how youcould construct an arbitrage portfolio.
Consider the following financial market with two
risky assets x and y as well as a risk-free asset f:
E[r].
x (10%, 8%)
•z (6.6%, 6.3%)
y (8%, 5%)
(0%, 3%) f
Is it possible to construct portfolio z with existing
assets? Explain.
Assume that the following two assets are priced according to the zero-beta security market line: asset 1 has expected return of 6% and beta 0.5; asset 2 has expected return 14% and beta 2. (i) A third asset is mispriced by the market: it has beta 1.5 and expected return of 8%. Explain how you can set up a portfolio to exploit the arbitrage opportunity. What is the expected return of such portfolio? [33%] (ii) A fourth asset is mispriced by the market: it has beta 1.2 and expected return of 18%. Explain how you can set up a portfolio to exploit the arbitrage opportunity. What is the expected return of such portfolio? [33%] (iii) What should be the expected return for an asset with beta 0.8?
Chapter 7 Solutions
CONNECT WITH LEARNSMART FOR BODIE: ESSE
Ch. 7 - Prob. 1PSCh. 7 - Consider the statement: “If we can identify a...Ch. 7 - Are the following true or false? Explain. (LO 7-5)...Ch. 7 - Here are data on two companies. The T-bill rate is...Ch. 7 - Characterize each company in the previous problem...Ch. 7 - What is the expected rate of return for a stock...Ch. 7 - Kaskin, Inc., stock has a beta of 1.2 and Quinn,...Ch. 7 - What must be the beta of a portfolio with E(rf)) =...Ch. 7 - The market price of a security is $40. Its...Ch. 7 - You arc a consultant to a large manufacturing...
Ch. 7 - Consider the following table, which gives a...Ch. 7 - Prob. 13PSCh. 7 - Prob. 14PSCh. 7 - If the simple CAPM is valid, which of the...Ch. 7 - Prob. 16PSCh. 7 - If the simple CAPM is valid, which of the...Ch. 7 - Prob. 18PSCh. 7 - Prob. 19PSCh. 7 - Prob. 20PSCh. 7 - In problem 2123 below, assume the risk-free rate...Ch. 7 - Prob. 22PSCh. 7 - In problem 2123 below, assume the risk-free rate...Ch. 7 - Two investment advisers are comparing performance....Ch. 7 - Suppose the yield on short-term government...Ch. 7 - Based on current dividend yields and expected...Ch. 7 - Consider the following data for a single index...Ch. 7 - Assume both portfolios A and B are well...Ch. 7 - Prob. 29PSCh. 7 - Prob. 30PSCh. 7 - Et
Ch. 7 - Suppose two factors are identified for the U.S....Ch. 7 - Suppose there are two independent economic...Ch. 7 - As a finance intern at Pork Products, Jennifer...Ch. 7 - Suppose the market can be described by the...Ch. 7 - Which of the following statements about the...Ch. 7 - Kay, a portfolio n1anacr at Collins Asset...Ch. 7 - Prob. 3CPCh. 7 - Jeffrey Bruner, CFA, uses the capital asset...Ch. 7 - Prob. 5CPCh. 7 - According to CAPM, the expected rate of a return...Ch. 7 - Prob. 7CPCh. 7 - Prob. 8CPCh. 7 - 9. Briefly explain whether investors should expect...Ch. 7 - Assume that both X and Y are well-diversified port...Ch. 7 - Prob. 11CPCh. 7 - 12. A zero-investment, well-diversified portfolio...Ch. 7 - 13. An investor takes as large a position as...Ch. 7 - In contrast to the capital asset pricing model,...Ch. 7 - Prob. 1WMCh. 7 - Prob. 2WMCh. 7 - Prob. 3WMCh. 7 - a. Which of the stocks would you classify as...
Knowledge Booster
Learn more about
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
- Suppose you observe the following situation:Security Beta Expected ReturnDiamond Co 1.3 0.2Spade Co 0.8 0.14 (a) According to the above information, could we figure out the market return and risk-free rate? Explain your answer. (b) Discuss the possibility of including zero beta or negative beta assets in your portfolio. Explain the pros and cons of including these types of assets.arrow_forward4) Assume that both X and Y are well-diversified portfolios and the risk-free rate is 8%. Expected Return X Y 16% 12% In this situation you could conclude that portfolios X and Y: a) Are in equilibrium b) Not in equilibrium c) Are both underpriced d) Are both fairly priced Beta 1.00 0.25 Iarrow_forwardWe believe that the single factor model can predict any individual asset’s realized rate of return well. Both Portfolio A and Portfolio B are well-diversified: ri = E(ri) + βiF + Ei, where E(ei) = 0 and Cov(F, i) = 0 A B β 1.2 0.8 E(r) 0.1 0.08 (1) What is the rate of return of the risk-free asset? (2) What is the expected rate of return of the well-diversified portfolio C with βC = 1.6, which also exists in the market? (3) A fund constructs a well-diversified portfolio D. Studies show that βD = 0.6. The expected rate of return of D is 0.06. Is there an arbitrage opportunity? If so, construct a trading strategy to earn profits with no risk. If not, why?arrow_forward
- Suppose the CAPM is true. Consider two assets, X and Y, and the market M. Suppose cov(X,M) = .3, cov(Y,M) = .5. %3D (a) Is the expected return higher on X or Y? (b) Suppose var(M) = 1.5, what are the betas of X and Y? (c) Suppose the expected market return is 20% and the risk free rate is 5%, what is the expected returns of X and Y?. (d) Given your analysis in (a)-(c), what type of investor would prefer asset X to asset Y?arrow_forwardUse the figure for the question(s) below. Consider the following graph of the security market line: Average excess return (%) 12 10 Portfolio "A" 8 Portfolio "B" 6 Portfolio "C" 4 Market Portfolio 2 Portfolio "D" 2 Beta Portfolio "B": O A. falls above the SML. O B. is overpriced. OC. has a positive alpha. O D. is less risky than the market portfolio.arrow_forwardConsider the one-factor APT. Assume that two portfolios, A and B, are well diversified. The betas of portfolios A and B and the respective returns are reported below. Assuming no arbitrage opportunities exist, the risk-free rate of return must be: Portfolio β Expected Return A 0.2 9% B 1.2 19% Group of answer choices 8% 9% 6% 7%arrow_forward
- Consider a world with only two risky assets, A and B, and a risk-free asset. The two riskyassets are in equal supply in the market, i.e., the market portfolio M = 0.5A + 0.5B. Itis known that R¯M = 11%, σA = 20%, σB = 40% and ρAB = 0.75. The risk-free rate is2%. Assume CAPM holds.(a) What is the beta for each stock?(b) What are the values for R¯A and R¯B?arrow_forwardConsider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of return is 3%. The following information is available about two well-diversified portfolios: Portfolio B on F1 B on F2 Expected Return 0.5 1.5 11.5% 2.0 -1.0 9.0% Assuming no arbitrage opportunities exist, the risk premium on the factor portfolios F1 and F2 should be: A B O a. 12.14%, 9.29% O b. 9.29%, 12.14% O c. 5%,4% O d. 4%,5%arrow_forwarda) Suppose the risk-free rate is `X'% and the expected rate of return on the market portfolio is 10%. In your view, the expected rate of return of a security is 12.2%. Given that this security has a beta of 1.4, do you consider it to be overpriced, under-priced or fairly priced according to the Capital Asset Pricing Model? Please provide the details of your calculations and discuss your results. b) Using a graph, explain when a security is overpriced, under-priced or fairly priced according to the Capital Asset Pricing Model. Plot your answer from (a) onto this graph.arrow_forward
- 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?arrow_forwardAssume that security returns are generated by the single-index model,Ri = αi + βiRM + eiwhere Ri is the excess return for security i and RM is the market’s excess return. The risk-free rate is 2%. Suppose also that there are three securities A, B, and C, characterized by the following data: Security βi E(Ri) σ(ei) A 0.7 7 % 20 % B 0.9 9 6 C 1.1 11 15 a. If σM = 16%, calculate the variance of returns of securities A, B, and C. b. Now assume that there are an infinite number of assets with return characteristics identical to those of A, B, and C, respectively. What will be the mean and variance of excess returns for securities A, B, and C? (Enter the variance answers as a percent squared and mean as a percentage. Do not round intermediate calculations. Round your answers to the nearest whole number.)arrow_forward4. Suppose portfolio P's expected return in 12%, its volatility (standard deviation) is 20%, and the risk-free rate is 5%. Suppose further that a particular mix of asset i and P yields a portfolio P’with an expected return of 18% and a volatility of 30%. a. Compute for the Sharpe ratio of P. b. Compute for the Sharpe ratio of P'. Is adding asset i beneficial? Explain.arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Essentials Of InvestmentsFinanceISBN:9781260013924Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.Publisher:Mcgraw-hill Education,
Foundations Of FinanceFinanceISBN:9780134897264Author:KEOWN, Arthur J., Martin, John D., PETTY, J. WilliamPublisher:Pearson,
Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781337395250Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i...FinanceISBN:9780077861759Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan ProfessorPublisher:McGraw-Hill Education
Essentials Of Investments
Finance
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:9780134897264
Author:KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:Pearson,
Fundamentals of Financial Management (MindTap Cou...
Finance
ISBN:9781337395250
Author:Eugene F. Brigham, Joel F. Houston
Publisher:Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i...
Finance
ISBN:9780077861759
Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:McGraw-Hill Education
Investing For Beginners (Stock Market); Author: Daniel Pronk;https://www.youtube.com/watch?v=6Jkdpgc407M;License: Standard Youtube License