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Exercise 7

This document contains 5 exercises related to portfolio analysis and the Capital Asset Pricing Model (CAPM). Exercise 1 involves calculating returns and variances of portfolios with different asset allocations. Exercise 2 involves calculating the capital market line given returns and standard deviations of two securities. Exercise 3 involves calculating the standard deviation of a market portfolio given covariance data. Exercises 4 and 5 involve using CAPM concepts to calculate betas, security market lines, and capital market lines for portfolios with multiple assets.

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Nhu Huynh
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30 views

Exercise 7

This document contains 5 exercises related to portfolio analysis and the Capital Asset Pricing Model (CAPM). Exercise 1 involves calculating returns and variances of portfolios with different asset allocations. Exercise 2 involves calculating the capital market line given returns and standard deviations of two securities. Exercise 3 involves calculating the standard deviation of a market portfolio given covariance data. Exercises 4 and 5 involve using CAPM concepts to calculate betas, security market lines, and capital market lines for portfolios with multiple assets.

Uploaded by

Nhu Huynh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Exercise Sheet 7

Exercise 1 Assume there are two stocks, A and B, with A = 1:4 and B =
0:8. Assume also that the CAPM model applies.
(i) If the mean return on the market portfolio is 10% and the risk-free rate
of return is 5%, calculate the mean return of the portfolios consisting of:
a. 75% of stock A and 25% of stock B,
b. 50% of stock A and 50% of stock B,
c. 25% of stock A and 75% of stock B.
(ii) If the idiosyncratic variations of the stocks are A = 4; B = 2 and
the variance of the market portfolio is 2M = 12, calculate the variance of the
portfolios in (a), (b), (c).
(iii) What are the mean return and variance of the portfolios if they are 50%
…nanced by borrowing?

Exercise 2 Assume there are just two risky securities in the market portfolio.
Security A, which constitutes 40% of this portfolio, has an expected return of
10% and a standard deviation of 20%. Security B has an expected return of
15% and a standard deviation of 28%. If the correlation between the assets is
0.3 and the risk free rate 5%, calculate the capital market line.

Exercise 3 The market portfolio is composed of four securities. Given the


following data, calculate the market portfolio’s standard deviation.
Security Covariance with market Proportion
A 242 0.2
B 360 0.3
C 155 0.2
D 210 0.3

Exercise 4 Given the following data, calculate the security market line and the
betas of the two securities.
Expected return Correlation with market portfolio Standard deviation
Security 1 15.5 0.9 2
Security 2 9.2 0.8 9
Market portfolio 12 1 12
Risk free asset 5 0 0

Exercise 5 Consider an economy with just two assets. The details of these are
given below.
Number of Shares Price Expected Return Standard Deviation
A 100 1.5 15 15
B 150 2 12 9
The correlation coe¢ cient between the returns on the two assets if 1/3 and
there is also a risk free asset. Assume the CAPM model is satis…ed.
(i) What is the expected rate of return on the market portfolio?
(ii) What is the standard deviation of the market portfolio?
(iii) What is the beta of stock A?

1
(iv) What is the risk free rate of return?
(vi) Construct the capital market line and the security market line.

Exercise 6 Consider an economy with three risky assets. The details of these
are given below.
No. of Shares Price Expected Return Standard Deviation
A 100 4 8 10
B 300 6 12 14
C 100 5 10 12
The correlation coe¢ cient between the returns on any pair of assets is 1/2
and there is also a risk free asset. Assume the CAPM model is satis…ed.
(i) Calculate the expected rate of return and standard deviation of the market
portfolio.
(ii) Calculate the betas of the three assets.
(iii) Use solution to (ii) to …nd the beta of the market portfolio.
(iv) What is the risk-free rate of return implied by these returns?
(v) Describe how this model could be used to price a new asset, D.

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