A CAPM Implications The CAPM implies that I all investors wh

A.

CAPM Implications The CAPM implies that
I. all investors who invest in risky assets will hold the same portfolio of risky assets.
II. the risk premium of an individual security is a function of the security\'s contribution to the risk of the market portfolio.
III. there is one unique market wide price of risk.
IV. all investors hold equal proportions of the risky and the riskless asset in their complete portfolio.

II and III only

I, II and IV only

I, II and III only

I and II only

B.

CAPM Calculations A stock has a beta of 1.21 when the risk free rate is 2.25% and the expected return on the market is 11.75%. The stock\'s required rate of return is equal to

C.

Alpha and Pricing The risk free rate is 1.55% and the market price of risk is 4%. A stock with a beta of 1.05 has an expected dividend yield of 2% and an expected capital gain of 5%. This stock\'s alpha is equal to ______ and the stock is ________.

+6.25%; overpriced

1.25%; underpriced

-6.25%; underpriced

-1.25%; overpriced

Solution

A)Correct option is \"B\" -I,II and IV is correct

CAPM implies that :

I. all investors who invest in risky assets will hold the same portfolio of risky assets.
II. the risk premium of an individual security is a function of the security\'s contribution to the risk of the market portfolio.

IV. all investors hold equal proportions of the risky and the riskless asset in their complete portfolio.

B)stock\'s required rate of return =Risk free rate+ [Beta(RM-RF)]

            = 2.25+ [1.21(11.75-2.25)]

             = 2.25 +[1.21 * 9.5]

             = 2.25+ 11.495

          = 13.745 % [rounded to 13.75%]

C)Return as per CAPM= Rf+ [beta * market risk premium]

       = 1.55+ [1.05*4]

          =1.55+ 4.2

          = 5.75%

REquired return = Dividend yield + capital gain yield

              = 2 +5

            = 7%

Alpha =required return - return as per CAPM

        =7- 5.75

        = 1.25%

correct option is \"B\"-1.25%; underpriced