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Suppose that all the unrealistic assumptions of the CAPM are true (the CAPM is valid)!!! The market portfolio has an expected return equal to 15% and the risk free rate is 5%. We are mainly interested in 2 securities in the market; stocks A and B. The beta of stock A is 1.8 and the expected return of stock B is 10%.

Estimate the expected return of the optimal risky portfolio.

Estimate the alpha of stock A.

Estimate the expected return and the beta of an equally weighted portfolio Z consisting of stocks A and B.

Estimate the alpha of portfolio Z.

User Marquis
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Final answer:

To estimate the expected return of the optimal risky portfolio, use the CAPM. The expected return is 23%. The alpha of stock A and portfolio Z cannot be determined with the given information.

Step-by-step explanation:

To estimate the expected return of the optimal risky portfolio, you need to use the Capital Asset Pricing Model (CAPM). According to the CAPM, the expected return of a security is equal to the risk-free rate plus the beta of the security multiplied by the market risk premium. In this case, the risk-free rate is 5% and the market risk premium is 15% - 5% = 10%. So, the expected return of the optimal risky portfolio is 5% + (1.8 * 10%) = 23%.

The alpha of stock A can be estimated by subtracting the stock's expected return based on the CAPM from its actual return. The actual return of stock A is not given in the question, so it's not possible to determine the alpha of stock A.

An equally weighted portfolio Z consisting of stocks A and B has a beta equal to the average of the individual betas of the stocks. In this case, the beta of the portfolio Z would be (1.8 + 1) / 2 = 1.4. The expected return of the portfolio Z can be estimated using the CAPM, which gives us 5% + (1.4 * 10%) = 19%.

Similarly, the alpha of portfolio Z can be estimated by subtracting the portfolio's expected return based on the CAPM from its actual return. The actual return of portfolio Z is not given in the question, so it's not possible to determine the alpha of portfolio Z.

User Arief Hidayat
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