Question (in proper order)
If the simple CAPM is valid and all portfolios are priced correctly, which of the situations below is possible? Consider each situation independently, and assume the risk-free rate is 5%.
A)
Portfolio Expected Return Beta
A 11 % 1.1
Market 11 % 1.0
B)
Portfolio Expected Return Standard Deviation
A 14 % 11 %
Market 9 % 19 %
C)
Portfolio Expected Return Beta
A 14 % 1.1
Market 9 % 1.0
D)
Portfolio Expected Return Beta
A 17.6 % 2.1
Market 11 % 1.0
Option A
Option B
Option C
Option D
Answer and Explanation:
A) As Per CAPM
Expected Return = Risk free rate + Beta × (Market Return - Risk free Rate)
= 5% + 1.1 × (11% - 5%)
= 11.60%
(Portfolio is not correctly Priced)
B) Standard Deviation alone cannot determine expected return using CAPM
C) As Per CAPM
Expected Return = Risk free rate + Beta × (Market Return - Risk free Rate)
= 5% + 1.1 × (9% - 5%) = 9.40%
(Portfolio is not correctly Priced)
D) As Per CAPM
Expected Return = Risk free rate + Beta × (Market Return - Risk free Rate)
= 5% + 2.1 × (11% - 5%) = 17.60%
Required Rate and Expected Return of Portfolio are Same
(Portfolio is correctly Priced)
Option D is correct option