CAPM

1) Investors expect the market rate of return this year to be 10%. The expected rate of return
on a stock with a beta of 1.2 is currently 12%. If the market returns this year turns out to
be 8%, how would you revise your expectations of the rate of return on stock.

2) Investors expect the market rate of return this year to be 13.00%. The expected rate of
return on a stock with a beta of 1.6 is currently 20.80%. If the market returns this year
turns out to be 11.40%, how would you revise your expectation of the rate of return on
the stock?

3) Consider the CAPM. The risk-free rate is 6%, and the expected return on the market is
18%. What is the expected return on a stock with a beta of 1.3?
Rrf = 6 %, Rm= 18 %, b = 1.3, Rs = ?

Rs = Rrf + b (Rm - Rrf)

= 0.06 + (1.3)(0.18 – 0.06)
= 0.2160 = 21.6 %

4) Consider the CAPM. The risk-free rate is 5%, and the expected return on the market is
15%. What is the beta on a stock with an expected return of 17%?
Rrf = 5 %, Rm= 15 %, Rs = 17%, b = ?

b = (Rs - Rrf) / (Rm - Rrf)

= (0.17 – 0.05) / (0.15 – 0.05)
= 1.2
5) What is the market risk premium given an expected return on a security of 13.6%, a stock
beta of 1.2, and a risk free interest rate of 4.0%?
Rs = 13.6 %, b = 1.2, Rrf = 4.0 %, MRP = ?

MRP = (Rs - Rrf) / b

= (0.136 – 0.04) / 1.2
= 0.08
 6) Consider two stocks, A and B. Stock A has an expected return of 10% and a beta of 1.2.
Stock B has an expected return of 14% and a beta of 1.8. The expected market rate of
return is 9% and the risk-free rate is 5%. Security __________ would be considered the
better buy because __________.
A; it offers an expected excess return of 0.2%
A; it offers an expected excess return of 2.2%
B; it offers an expected excess return of 1.8%
B; it offers an expected return of 2.4%

Excess Return = Rs – [Rrf + b (Rm - Rrf)]

Stock A: Rs = 10 %, b = 1.2, Rm = 9 %, Rrf = 5 %

Excess Return = 0.10 – [0.05 + (1.2)(0.09 – 0.05)]
= 0.0020 = 0.2 %

Stock B: Rs = 14 %, b = 1.8, Rm = 9 %, Rrf = 5 %

Excess Return = 0.14 – [0.05 + (1.8)(0.09 – 0.05)]
= 0.018 = 1.8 %

7)

What is the return in market portfolio?

8)

What is the beta for a portfolio with an expected return of 12.5%?

Rs = 12.5 %, Rrf = 5 %, Rm= 10 %, b =?
b = (Rs - Rrf) / (Rm - Rrf)
= (0.125 – 0.05) / (0.10 – 0.05)
=2
9)

What is the alpha of a portfolio with a beta of 2 and actual return of 15%?
Actual Return = 15 %, Rrf = 5 %, Rm= 10 %, b = 2

Rs = Rrf + b (Rm - Rrf)

= 0.05 + (2)(0.10 – 0.05)
= 0.15 = 15 %
a1 = actual return - expected return

a1 = 0.15 – 0.15 = 0
10)

R1 = 19%, b1 = 1.5, R2 = 16%, b2 = 1

a. To determine which adviser is a better stock selector, we need to calculate the alpha for each
investment. Without considering the risk-free rate and market return, we cannot accurately
determine which adviser is better at stock selection.
b.
First Investment:
Rf = 6%, b = 1.5, RM = 14%
Expected Return = Rf + b (RM - Rf)
= 0.06 + (1.5) (0.14 – 0.06)
= 0.18
a1 = actual return - expected return
= 0.19 – 0.18 = 0.01 = 1%

Second Investment:
Rf = 6%, b = 1, RM = 14%
Expected Return = Rf + b (RM - Rf)
= 0.06 + (1) (0.14 – 0.06)
= 0.14
a2 = actual return - expected return
= 0.16 – 0.14 = 0.02 = 2%

The second investment adviser has a higher alpha of 2% compared to the first adviser's 1%.
Therefore, the second investment adviser is considered the superior stock selector.
c.
First Investment:
Rf = 3%, b = 1.5, RM = 15%
Expected Return = Rf + b (RM - Rf)
= 0.03 + (1.5) (0.15 – 0.03)
= 0.21
a1 = actual return - expected return
= 0.19 – 0.21 = - 0.02 = - 2%

Second Investment:
Rf = 3%, b = 1, RM = 15%
Expected Return = Rf + b (RM - Rf)
= 0.03 + (1) (0.15 – 0.03)
= 0.15
a2 = actual return - expected return
= 0.16 – 0.15 = 0.01 = 1%

The first investment adviser has an alpha of -2%, indicating underperformance compared to the
second adviser, which has an alpha of 1%. Therefore, the second investment adviser is the
superior stock selector.