question archive Suppose your investment advisor give you the following information: 2 Osi Assets X ? 02 10% 30
Suppose your investment advisor give you the following information: 2 Osi Assets X ? 02 10% 30
Subject:FinancePrice:2.86 Bought3
Suppose your investment advisor give you the following information: 2 Osi Assets X ? 02 10% 30.25% 7.75% 10% Bi 0.6 1.8 In addition, the market has expected return of 15%, and the risk-free rate is 5% 1) The advisor tells you that the current price of X implies an expected return of 13% and the current price of A implies an expected return of 17%. According to the CAPM what position (long or short) should you take in each of the two securities? Why? (6 marks) 2) According to the CAPM, what is the expected return of an equally-weighted portfolio consisting of the two stocks? What is the systematic risk portion of the portfolio variance? (9 marks)
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1) Calculation of CAPM return
Formula = Rf + Beta (Rm - Rf)
Where,
Rf is risk free return i.e. 5%
Rm is market rate of return i.e. 15%
|
Particulars |
X |
A |
|
Rm-Rf |
10% |
10% |
|
Beta |
0.6 |
1.8 |
|
CAPM return |
11.00% |
23.00% |
Analysis
|
Particulars |
X |
A |
|
CAPM return |
11.00% |
23.00% |
|
Expected return |
13.00% |
17.00% |
|
Position |
Long |
Short |
|
Reason |
Underpriced |
Over priced |
2)
a) Expected return of an equally weighted portfolio
|
Asset |
Weight |
CAPM return |
Product |
|
X |
0.5 |
11.00% |
5.50% |
|
A |
0.5 |
23.00% |
11.50% |
|
17.00% |
b) Calculation of Unsystematic portion of risk of portfolio
|
Asset |
Weight |
Random error |
|
X |
0.5 |
7.75% |
|
A |
0.5 |
10% |
Unsystematic risk = 0.5*0.5*7.75% + 0.5*0.5*10% = 4.4375%
