7．Janet Bellows, a portfolio manager, is attempting to explain asset valuation to a junior colleague, Bill Clay. Bellows explanation focuses on the capital asset pricing model (CAPM). Of particular interest is her discussion of the security market line (SML), and its use in security selection. Bellows begins with a short review of the capital asset pricing model, including a discussion about its assumptions regarding transaction costs, taxes, holding periods, return requirements, and borrowing and lending at the risk-free rate. Bellows then illustrates the SML, and explains how changes in the expected market return and the risk-free rate affect the line. In an effort to learn whether Clay understands the concepts she has explained to him, Bellows decides to test Clay’s knowledge of valuation using the CAPM. Bellows provides the following information for Clay: §
The risk-free rate is 7 percent. §
The market risk premium during the previous year was 5.5 percent. §
The standard deviation of market returns is 35 percent. §
This year, the market risk premium is estimated to be 7 percent. §
Stock A has a beta of 1.30 and is expected to generate a 15.5 percent return. §
The covariance of Stock B with the market is 0.18. §
The standard deviation of Stock B’s returns is 41 percent. Using this information, Clay must calculate expected stock returns and betas. Bellows especially wants to know Stock A’s required return, and whether or not the stock is a good buy. Bellows then proposes a hypothetical situation to Clay: The stock market is expected to return 12.5 percent next year. Clay questions that return estimate in the context of the data listed above, and Bellows responds with four possible explanations for the estimate: §
The estimated risk premium is incorrect. §
Interest rates are likely to fall 1.5 percent over the next year. §
Given the data above, the return estimate is correct. §
The market beta is expected to rise over the next year. Then Bellows provides Clay with the following information about Ohio Manufacturing, Texas Energy, and Montana Mining: Stock | Ohio | Texas | Montana | Beta | 0.50 | XX% | 1.50 | Required Return | 10.5% | 11.0% | XX% | Expected Return | 12.0% | 10.0% | 15.0% | Expected S& 500 return | 14.0% |
Clay has been tasked with providing an investment recommendation on the three stocks. Based on the stock and market data provided above, which of the following data regarding Stock A is most accurate? Required
12-month return | Investment advice
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A) 16.1% Sell B) 16.1% Buy C) 14.15% Sell D) 14.15% Buy The correct answer was A) ERstock = Rf + βstock ( ERM - Rf ). = 7% + 1.3 (14% - 7%) = 16.1%. The market risk premium for the upcoming year should be used in the calculation. Stock A’s required return is higher than its expected return, and as such the stock plots below the security market line. Stock A should be sold, not bought. 8．The beta of Stock B is closest to: A) 1.47. B) 0.51. C) 1.07. D) 0.44. The correct answer was A) Beta = (covariance of stock B with the market)/(variance of the market portfolio)
= 0.18/(0.35) 2 = 1.47. 9．Which of the following represents the best investment advice? A) Buy Montana because it is expected to return more than Texas, Ohio, and the market portfolio. B) Buy Texas and Ohio because their betas are lower than that of Montana. C) Avoid Texas because its expected return is lower than its required return. D) Buy Montana and Texas because their required return is lower than their expected return. The correct answer was C) We can use the security market line (SML) to estimate the required return or beta on the various securities, and compare this with the expected returns. The SML looks like this: E(r) = Rrf + β (RPM). Since Montana’s beta is 1.50: 7.0 + 1.50(7.0) = 17.5 percent = the required return. Because Montana’s expected return is 15.0 percent, and the required return is 17.5 percent, Montana should not be purchased. Note that this is true even though Montana’s expected return is more than the other stocks and the market: it is not enough to compensate for the level of market risk assumed by holding the stock. Texas’ required return = 11.0 = 7.0 + β(7.0), so β = 4/7 = 0.57. However, its expected return is less than the required return, so regardless of the beta value, Texas should not be purchased. Ohio’s required return is given as 10.5, and the expected return is 12.0. Hence, Ohio is a buy. 10．Assuming the market return estimate of 12.5 percent is accurate, which of the following statements is the best explanation for the estimate? A) Interest rates are likely to fall 1.5 percent over the next year. B) The estimated risk premium is incorrect. C) Given the data above, the return estimate is correct. D) The market beta is expected to rise over the next year. The correct answer was B) The expected return on the market during the upcoming year is 14 percent (7 percent risk-free rate plus the expected 7 percent market risk premium). As such, the 12.5 percent estimate does not match the data. The most rational justification for a lower expected return is an error in the estimated risk premium. Falling interest rates may boost expected stock returns, but the current rate is the most relevant to the projected market return for the upcoming year. The market beta by definition is 1.0, and this does not change. 11．With regards to the capital asset pricing model, relaxing assumptions about: A) homogeneous expectations will result in the SML appearing more as a band instead of a line. B) taxes will reduce differences between the capital market lines of different investors. C) transaction costs will make investors more likely to sell, and less likely to hold. D) risk free borrowing and lending rates results in a lower intercept and steeper slope. The correct answer was A) Taxes change investors’ return expectations. Considering different marginal tax rates will result in a vast array of different after-tax requirements, leading to a vast array of CMLs and SMLs for different investors. The assumption of no transaction costs allows investors to make a profit even if a stock is just slightly off the SML. Add transaction costs into the mix, and investors will not sell stocks close to the SML unless the profit exceeds the transaction costs. As such, investors will be more likely to hold, rather than sell, because stocks that could be sold for a profit under the pure CAPM cannot be sold for a profit after transaction costs. If risk-free borrowing and lending does not exist, then a portfolio of risky securities must be created such that the portfolio beta equals zero. The zero-beta portfolio is similar to the risk-free asset in that both have zero betas, but they differ in that the zero-beta portfolio has a non-zero standard deviation. The expected return on the zero-beta portfolio exceeds the risk-free rate therefore the SML will now have a higher intercept and a flatter slope. 12．If the market risk premium decreases by 1 percent, while the risk-free rate remains the same, the security market line: A) becomes steeper. B) parallel-shifts upward. C) becomes flatter. D) parallel-shifts downward. The correct answer was C) Since the security market line runs from the risk-free rate (RFR) through the market return, holding the RFR constant and decreasing the market risk premium will cause the SML to become flatter. | 
发表于 2008-4-14 17:37
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