Suppose you’ve estimated that the fifth-percentile value at risk of a portfolio is -30%. Now you wish to estimate the portfolio’s first-percentile VaR (the value below which lie 1% of the returns). Will the 1% VaR be greater or less than -30%?
1% VaR will be less than -30%.
Fifth-percentile VaR of a portfolio = -30%
VaR or “Value at Risk” is the measure of downside risk.
In the above scenario, since the percentile or probability of a return has declined, the magnitude of that return will also decline. Thus, a 1 percentile probability will produce a smaller VaR than a 5 percentile probability. Therefore 1% VaR will be less than -30%.
Suppose the yield on short-term government securities (perceived to be risk-free) is about 4%. Suppose also that the expected return required by the market for a portfolio with a beta of 1 is 12%. According to the capital asset pricing model:
a. What is the expected return on the market portfolio?
b. What would be the expected return on a zero-beta stock?
c. Suppose you consider buying a share of stock at a price of $40. The stock is expected to pay a dividend of $3 next year and to sell then for $41. The stock risk has been evaluated at β = - .5. Is the stock overpriced or underpriced?
If the simple CAPM is valid, which of the situations in Problems 13 – 19 below are possible? Explain. Consider each situation independently.
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