question archive Under CAPM, the portfolios appeared are in equilibrium, is the following situation possible? Standard Deviation Portfolio Expected Return Standard Deviation 1 Portfolio Expected Return z Ri ? B 30 40 35 25 Risk-free Market A 10 18 20 0 24 22 Portfolio Standard Deviation Portfolio Expected Return Beta Expected Return 4 ? 20 25 1
Under CAPM, the portfolios appeared are in equilibrium, is the following situation possible? Standard Deviation Portfolio Expected Return Standard Deviation 1 Portfolio Expected Return z Ri ? B 30 40 35 25 Risk-free Market A 10 18 20 0 24 22 Portfolio Standard Deviation Portfolio Expected Return Beta Expected Return 4 ? 20 25 1
Subject:FinancePrice:2.86 Bought3
Under CAPM, the portfolios appeared are in equilibrium, is the following situation possible? Standard Deviation Portfolio Expected Return Standard Deviation 1 Portfolio Expected Return z Ri ? B 30 40 35 25 Risk-free Market A 10 18 20 0 24 22 Portfolio Standard Deviation Portfolio Expected Return Beta Expected Return 4 ? 20 25 1.4 1.2 Risk-free Market A 10 18 16 0 24 12 B
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Solution:
Scenario 1: Stock A has higher firm-specific risk compared to Portfolio B. Here, the standard deviation of Portfolio A is higher than Portfolio B.
Therefore, the situation is “Possible”.
Scenario 2:
Portfolio beta = [(20%-10%) / (18%-10%)] = 1.25
Firm-Specific Risk = [(22%)2 – (1.25)2 * (24%)2] = -0.0416
Here, the firm-specific risk is negative.
Therefore, the situation is “Not Possible”.
Scenario 3:
20%=Riskfree Rate + 1.4 * (Market Return – Riskfree Rate) >> (1)
25%=Riskfree Rate + 1.2 * (Market Return – Riskfree Rate) >> (2)
Solving the above two equations, we get the riskfree rate as 55%. Here, the riskfree rate is very abnormal at 55%.
Therefore, the situation is “Not Possible”.
Scenario 4:
The standard deviation of market of 24% is higher than Stock A.
Therefore, the situation is “Not Possible”.
