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Q18I.

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Essentials Of Investments
Found in: Page 226
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

Short Answer

If the simple CAPM is valid, which of the situations in Problems 13 – 19 below are possible? Explain. Consider each situation independently.

The correct answer would be “Not Possible”

See the step by step solution

Step by Step Solution

Given Information

Expected return of Portfolio = 16%

Beta = 0.9

Risk free rate = 10%

Market expected rate = 18%

Given these data, the SML is: E(r) = 10% + β(18% – 10%)

Finding the required rate of return for Portfolio A

Here, the required expected return for Portfolio A is:

E (r) = r f + β [E(rM – rf)]

E(r) = 10% + (0.9% x 8%) = 17.2%

This is still higher than 16%. Portfolio A is overpriced, with alpha equal to: –1.2%

This is inconsistent with the CAPM hence “Not Possible’.

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