Question

The stock of ABC Corporation has a beta of 1.8 ABC Corporation earned an annual return of 14 percent during a period when the return on the market portfolio was 12.5 percent. If the risk-free rate was 6 percent, did ABC Corporation outperform the market on a risk-adjusted basis?

Answer 1

See explanations for step by step aoproach to answer and see attachment for graph

Step-by-step explanation:

Plot E(R) = Rf + Beta*(Rm-Rf) as function of beta.

at 1.4

E(R) = 5% + 1.4*(12-5) = 14.8%

E(R) = WfRf + Wa*E(Ra)

= 0.4*5% + 0.6*14.8%

= 10.88%

3. Since, the beta of risk free asset is zero

Bp = wf*Bf + wa*Ba

0.6 = 1.4*wa

wa = 42.8%

wf = 57.2%

d. 14% = 5% + B*(12%-5%)

B = 9/7 = 1.28

e. 2 = wfBf + waBa

wa = 2/1.4

= 142%

It means the portfolio is created by leveraging. Take 42% of value on risk free rate as loan and invest in risky asset.