Problem 1: According to the CAPM, what is the expected return on a security give
ID: 2733004 • Letter: P
Question
Problem 1: According to the CAPM, what is the expected return on a security given a market risk premium of 12%, a stock beta of 1.44, and a risk free interest rate of 1%? Put the answers in decimal place.
Problem 2:
Consider the following two stocks, A and B. Stock A has an expected return of 10%, 10% standard deviation, and a beta of 1.20. Stock B has an expected return of 14%, 25% standard deviation, and a beta of 1.80. The expected market rate of return is 9% and the risk-free rate is 5%. Security __________ would be considered a good buy if we include the stock in a well diversified a portfolio because _________.
B, it offers better alpha
A, it offers better alpha
A, it offers better Sharpe ratio
Explanation / Answer
Problem 1 The expected return on the security = (12% - 1%) X 1.44 = 15.8% Problem 2 Security B would be considered a good buy if we include the stock in a well diversified a portfolio because it offers better alpha.