Essentials of Investments (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
10th Edition
ISBN: 9780077835422
Author: Zvi Bodie Professor, Alex Kane, Alan J. Marcus Professor
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 7, Problem 27PS
Consider the following data for a single index economy. All portfolios are well diversified.
Portfolio E® Beta A 10% 1.0 F 4 0
Suppose another portfolio E is well diversified with a beta of 2/3 and expected return of 9%. Would an arbitrage opportunity exist? 1f so, what would the arbitrage strategy be (LO 7.4)
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QUESTIONS AND PROBLEMS
1. Assume that the following two-index model describes returns:
R=a+b+b212 +e;
Assume that the following three portfolios are observed.
Portfolio
ABC
Expected Return
12.0
13.4
12.0
bil
b₁₂
0.5
1
0.2
3
-0.5
3
Find the equation of the plane that must describe equilibrium returns.
111 illustrate the arbitrage opportunities that
Consider the following data for a one-factor economy. All portfolios are assumed to be well diversified.
Portfolio. A. F
Expected return 12% 6%
Beta. 1.2 0.0
Suppose that another portfolio, portfolio E, is well diversified with a beta of 0.6 and expected return of 8%. Would an arbitrage opportunity exist? If so, what would be the arbitrage strategy? (Note: show what the percentage profit from arbitrage will be)
Suppose that you know that the following well-diversified portfolios are fairly
priced in a two-factor economy where the risk-free rate is 5%. Determine the
risk premiums associated with each factor and compute the expected market
risk premium for the next period based on these figures.:
betal
beta 2
E(r)
p1
1.00
-.5
10%
p2
-.5
1.50
10%
Chapter 7 Solutions
Essentials of Investments (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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 - Prob. 8PSCh. 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...
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- How to solve from essentials of investment chapter 7?arrow_forwardConsider a single-index model economy. The index portfolio M has E(RM ) = 6%, σM = 18%.An individual asset i has an estimate of βi = 1.1 and σ2ei = 0.0225 using the single index modelRi = αi + βiRM + ei. The forecast of asset i’s return is E(ri) = 12%. rf = 4%. a) According to asset i’s return forecast, calculate αi. (b) Calculate the optimal weight of combining asset i and the index portfolio M . (c) Calculate the Sharpe ratio of the index portfolio M and the portfolio optimally combiningasset i and the index portfolio M .arrow_forwardSuppose that there are two independent economic factors, F1 and F2. The risk-free rate is 6%. The following are well-diversified portfolios: Portfolio Beta on F1 Beta on F2 Expected Return A 1.5 2.0 31% B 2.2 -0.2 27% [i]. What is the risk premium for F1?arrow_forward
- Consider the following information: Expected Return Portfolio Risk-free Market A Expected return 10% 15.0 11.2 Alpha Required: a. Calculate the expected return of portfolio A with a beta of 0.6. (Round your answer to 2 decimal places.) Beta 0 1.0 0.6 % b. What is the alpha of portfolio A. (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.) % Chearrow_forwardvvk.1 Portfilio A has an expected return of 12% and a beta of1.2. Portfolio B has an expected return of 5% and a beta of 0. suppose there exists another portfolio C that is well diversifed and has a beta of 0.6 and expected return of 8%. If arbitrage is possible, what would be the return?arrow_forwardUsing CAPM to determine the expected rate of return for risky assets, consider the following example stocks, assuming that you have already compute the betas Stock Beta A 0.70 B 1.00 C 1.15 D 1.40 E -0.30 Assume that we expect the economy’s RFR to be 5 percent (0.05) and the expected return on the market portfolio (E(RM)) to be 9 percent (0.09), 1, what would this imply? With these inputs, what would the be the following required rate of returns for these five stocks, show the formula for each in your calculations.arrow_forward
- Consider an economy with just two assets. The details of these are given below. Number of Shares Price Expected Return Standard Deviation A 100 1.5 15 15 B 150 2 12 9 The correlation coefficient between the returns on the two assets is 1=3 and there is also a risk-free asset. Assume the CAPM model is satisfied. (1) What is the expected rate of return on the market portfolio? (2) What is the standard deviation of the market portfolio? (3) What is the beta of stock A? (4) What is the risk-free rate of return?arrow_forwardNikularrow_forward3arrow_forward
- Consider the following information: Portfolio Expected Return Standard Deviation Risk-free 7% 0% Market 11.6 28 A 10.0 17 Required: a. Calculate the Sharpe ratios for the market portfolio and portfolio A. (Round your answers to 2 decimal places.) b. If the simple CAPM is valid, is the above situation possible?arrow_forwardconsider the following data for a single factor model economy. all portfolios are well diversified. suppose portfolio p has an expected return of 19% and beta of 2.0. portfolio m has an expected retrun of 12% and beta of 1.0. assume that the risk free rate is 7% and that arbitrage opportunities exist. what is the portfolio p's alpha?arrow_forwardFor each of the cases shown in the following table, use the capital asset pricing model (CAPM) to find the required return and explain your answer. Case Risk-free rate Market return Beta (%) (%) 8 A 5 1.3 В 8. 13 0.9 C 9 12 -0.2 D 10 15 1.0 E 10 0.6arrow_forward
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