INVESTMENTS-CONNECT PLUS ACCESS
11th Edition
ISBN: 2810022611546
Author: Bodie
Publisher: MCG
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Chapter 7, Problem 13PS
Summary Introduction
To state: If the statement is true or false.
Introduction: Standard deviation is a measure of volatility in the
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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?
Assume you own a portfolio of diverse securities each of which is correctly priced. Given this, the reward-to-risk ratio:
of each security must equal the slope of the security market line.
for the portfolio must equal 1.0.
for the portfolio must be less than the market risk premium.
see attached image.
Chapter 7 Solutions
INVESTMENTS-CONNECT PLUS ACCESS
Ch. 7 - Prob. 1PSCh. 7 - Prob. 2PSCh. 7 - Prob. 3PSCh. 7 - Prob. 4PSCh. 7 - Prob. 5PSCh. 7 - Prob. 6PSCh. 7 - Prob. 7PSCh. 7 - Prob. 8PSCh. 7 - Prob. 9PSCh. 7 - Prob. 10PS
Ch. 7 - Prob. 11PSCh. 7 - Prob. 12PSCh. 7 - Prob. 13PSCh. 7 - Prob. 14PSCh. 7 - Prob. 15PSCh. 7 - Prob. 16PSCh. 7 - Prob. 17PSCh. 7 - Prob. 18PSCh. 7 - Prob. 19PSCh. 7 - Prob. 20PSCh. 7 - Prob. 21PSCh. 7 - Prob. 22PSCh. 7 - Prob. 23PSCh. 7 - Prob. 1CPCh. 7 - Prob. 2CPCh. 7 - Prob. 3CPCh. 7 - Prob. 4CPCh. 7 - Prob. 5CPCh. 7 - Prob. 6CPCh. 7 - Prob. 7CPCh. 7 - Prob. 8CPCh. 7 - Prob. 9CPCh. 7 - Prob. 10CPCh. 7 - Prob. 11CPCh. 7 - Prob. 12CPCh. 7 - Prob. 13CP
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- The 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 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 portfolioarrow_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
- As the number of stocks in a portfolio increase, the portfolio’s systematic risk can either increase or decrease. Select one: True Falsearrow_forwardWhich of the following statements regarding non-systematic risk, systematic risk and total risk is/are true? Select one or more:a. As the number of assets within a portfolio increases, the total risk of a portfolio will go to zero.b. A riskfree asset must have zero non-systematic risk.c. A well diversified portfolio must have zero systematic riskd. Under the Capital Asset Pricing Model (CAPM).an asset with zero systematic risk must have expected return equal to the riskfree rate.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 o(R) 0.4 0.45 [H]Z 0.3 0.25 0.2 0.15 0.1 0.05 0 0 0.05 0.1 Figure (2) shows an investor that borrows in risk-free rate and invests in the risky asset. Figure (1) shows an investor with a conservative investment behavior. In the optimal point of both figures, the highest indifference curve is tangent to the efficient frontier. In Figure (1), more aggressive investment decision led to a higher Sharpe ratio. 0.15 Figure 2 0.2 0.25 o (R) 0.3 0.35 0.4 0.45arrow_forward
- Which of the following statements about CAPM is true? a. The expected return of a zero-beta security or portfolio equals risk free rate. b. •The risk premium an investor expects to receive on any stock or portfolio increases with standard deviation. C. Beta measures total risk. On equilibrium, total risk is compensated by return. e. The beta of the market portfolio equals zero.arrow_forwardFind the weights of the two pure factor portfolios constructed from the following three securities: r1 = .06 + 2F¡ + 2F, r2 = .05 + 3F, + IF, r3 = .04 + 3F, + OF, Then write out the factor equations for the two pure factor portfolios, and determine their risk premiums. Assume a risk-free rate that is implied by the factor equations and no arbitrage.arrow_forwardConsider the following data for two risk factors (1 and 2) and two securities (J and L):λ0 = 0.07 λ1 = 0.04 λ2 = 0.06bJ1 = 0.10 bJ2 = 1.60 bL1 = 1.80 bL2 = 2.45a. Compute the expected returns for both securities. b. Suppose that Security J is currently priced at $50 while the price of Security L is $15.00.Further, it is expected that both securities will pay a dividend of $0.95 during the coming year.What is the expected price of each security one year from now? c. Compute the correlation between stock A and stock B considering the following data.Standard deviation of stock A = 10 percentStandard deviation of stock B = 17 percentCovariance between the two stocks = 90.arrow_forward
- need correct and urgentarrow_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_forwardConsider the following portfolio choice problem. The investor has initial wealth w andutility u(x) = (x^n) /n. There is a safe asset (such as a US government bond) that has netreal return of zero. There is also a risky asset with a random net return that has onlytwo possible returns, R1 with probability 1 − q and R0 with probability q. We assumeR1 < 0, R0 > 0. Let A be the amount invested in the risky asset, so that w − A isinvested in the safe asset.i) What are risk preferences of this investor, are they risk-averse, riskneutral or risk-loving?ii) Find A as a function of w.arrow_forward
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