Access over 20 million homework & study documents

Chapter 7 Capital Asset Pricing & Arbitrage Pricing Theory Exercises

Content type
User Generated
Subject
Finance
Type
Other
Rating
Showing Page:
1/15
Chapter 07 - Capital Asset Pricing and Arbitrage Pricing Theory
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
CHAPTER 07
CAPITAL ASSET PRICING AND ARBITRAGE PRICING THEORY
1. The required rate of return on a stock is related to the required rate of return on the stock
market via beta. Assuming the beta of Google remains constant, the increase in the risk of the
market will increase the required rate of return on the market, and thus increase the required
rate of return on Google.
2. An example of this scenario would be an investment in the SMB and HML. As of yet, there are
no vehicles (index funds or ETFs) to directly invest in SMB and HML. While they may prove
superior to the single index model, they are not yet practical, even for professional investors.
3. a. False. According to CAPM, when beta is zero, the “excess” return should be zero.
b. False. CAPM implies that the investor will only require risk premium for systematic risk.
Investors are not rewarded for bearing higher risk if the volatility results from the firm-specific
risk, and thus, can be diversified.
c. False. We can construct a portfolio with the beta of .75 by investing .75 of the investment
budget in the market portfolio and the remainder in T-bills.
4. E(r) = r
f
+ β [E(r
M
) r
f
] , r
f
= 4%, r
M
= 6%
$1 Discount Store: E(r) = 4% + 1.5 6% = 13%
Everything $5: E(r) = 4% + 1.0 6% = 10%

Sign up to view the full document!

lock_open Sign Up
Showing Page:
2/15
Chapter 07 - Capital Asset Pricing and Arbitrage Pricing Theory
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
5. $1 Discount Store is overpriced; Everything $5 is underpriced.
6. a. 15%. Its expected return is exactly the same as the market return when beta is 1.0.
7. Statement a is most accurate.
The flaw in statement b is that beta represents only the systematic risk. If the firm-specific risk
is low enough, the stock of Kaskin, Inc. could still have less total risk than that of Quinn, Inc.
Statement c is incorrect. Lower beta means the stock carries less systematic risk.
8. A. A long position in a portfolio (P) composed of portfolios A and B will offer an expected
return-beta trade-off lying on a straight line between points A and B. Therefore, we can
choose weights such that βP = βC but with expected return higher than that of portfolio C.
Hence, combining P with a short position in C will create an arbitrage portfolio with zero
investment, zero beta, and positive rate of return.
b. No, arbitrage opportunities would be taken advantage of quickly selling short portfolio C
will cause a rise in the E(r) of C.
c. The argument in part (a) leads to the proposition that the coefficient of β
2
must be zero in
order to preclude arbitrage opportunities.
9. E(r
p
)
= r
f
+ β [E(r
M
) r
f
] Given r
f
= 5% and E(r
M
)= 15%, we can calculate
20% = 5% + (15% 5%) = 1.5
10. If the beta of the security doubles, then so will its risk premium. The current risk premium for
the stock is: (13% 7%) = 6%, so the new risk premium would be 12%, and the new discount
rate for the security would be: 12% + 7% = 19%

Sign up to view the full document!

lock_open Sign Up
Showing Page:
3/15

Sign up to view the full document!

lock_open Sign Up
End of Preview - Want to read all 15 pages?
Access Now
Unformatted Attachment Preview
Chapter 07 - Capital Asset Pricing and Arbitrage Pricing Theory CHAPTER 07 CAPITAL ASSET PRICING AND ARBITRAGE PRICING THEORY 1. The required rate of return on a stock is related to the required rate of return on the stock market via beta. Assuming the beta of Google remains constant, the increase in the risk of the market will increase the required rate of return on the market, and thus increase the required rate of return on Google. 2. An example of this scenario would be an investment in the SMB and HML. As of yet, there are no vehicles (index funds or ETFs) to directly invest in SMB and HML. While they may prove superior to the single index model, they are not yet practical, even for professional investors. 3. a. False. According to CAPM, when beta is zero, the “excess” return should be zero. b. False. CAPM implies that the investor will only require risk premium for systematic risk. Investors are not rewarded for bearing higher risk if the volatility results from the firm-specific risk, and thus, can be diversified. c. False. We can construct a portfolio with the beta of .75 by investing .75 of the investment budget in the market portfolio and the remainder in T-bills. 4. E(r) = rf + β [E(rM) – rf ] , rf = 4%, rM = 6% $1 Discount Store: E(r) = 4% + 1.5  6% = 13% Everything $5: E(r) = 4% + 1.0  6% = 10% Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. ...
Purchase document to see full attachment
User generated content is uploaded by users for the purposes of learning and should be used following Studypool's honor code & terms of service.

Anonymous
Just what I was looking for! Super helpful.

Studypool
4.7
Trustpilot
4.5
Sitejabber
4.4