# What is measured by a stock’s “beta”? Suppose that stock A has a higher beta than stock B, but its r

Apr 16th, 2015
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What is measured by a stock’s “beta”? Suppose that stock A has a higher beta than stock B, but its rate of return has a lower standard deviation than that of stock B. According to the CAPM, which stock should be expected to offer a higher average rate of return? Explain. 16. According to the theory of interest rate parity, what determines a nation’s nominal exchange rate? Based on that theory, would you expect the U.S. dollar to appreciate or depreciate in foreign exchange markets following a rise in U.S. nominal interest rates, all else equal? Explain.

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Answer for one---------------------The security market line ("SML" or "characteristic line") graphs the systematic (or market) risk versus the return of the whole market at a certain time and shows all risky marketable securities. The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The x-axis represents the risk (beta), and the y-axis represents the expected return. The market risk premium is determined from the slope of the SML.The security market line is a useful tool for determining whether an asset being considered for a portfolio offers a reasonable expected return for risk. Individual securities are plotted on the SML graph. If the security's risk versus expected return is plotted above the SML, it is undervalued because the investor can expect a greater return for the inherent risk. A security plotted below the SML is overvalued because the investor would be accepting less return for the amount of risk assumed. Expected values for the SML are calculated with the following equation:Es = rf + Bs(Emkt - rf)Where: rf = the risk-free rateBs = the beta of the investmentEmkg = the expected return of the market Es = the expected return of the investmentThe beta is thus the sensitivity of the investment to the market or current portfolio. It is the measure of the riskiness of a project. When taken in isolation, a project may be considered more or less risky than the current risk profile of a company. By using the SML as a means

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