Part 1 Investment with a beta, b, of 1.70. The risk-free rate of return, RF, is

Question

Part 1 Investment with a beta, b, of 1.70. The risk-free rate of return, RF, is 8%, The return on the market portfolio of assets, rm, is 12%. This investment will earn an annual rate of return of 13%. Requirement what would you expect to happen to the investment's return? a. If the return on the market portfolio were to increase by 9% b, if the market return were to decline by 9%? b. use capital asset pricing model (CAPM) is used to find c. the basis of your calculation in part b, would you d. Assume that as a result of investors becoming less risk the required return on this investment, discuss the result? recommend this investment? Why or why not? averse, the market return drops by 2% to 7%, what impact would this change have on your responses in parts band c?

Explanation / Answer

a. If the return on the market portfolio were to increase by 9%, the investment is expected to increase by 9% * 1.7 = 15.30%

b. it will decline by 15.3%

c. required return = 8% + 1.7*4% = 14.40%

Since the actual return is lesser the portfolio is over priced

d. No this would not be recommended since it is overvalued and so the expected return is lesser than the required return

e. required return = 8% + 1.7*(10% - 8%) = 11.4%.......if drop is 2% market return will be 12% - 2% = 10%

required return = 11.40%

now the expected return is higher so the asset is underpriced. One can buy it.

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