土豆妮

Glimmer Glass has a correlation of 0.67 with the market portfolio, a variance of 23%, and an expected return of 14%. The market portfolio has an expected return of 11% and a variance of 13%. Glimmer stock is approximately:

A) 11% less volatile than the average stock.

B) 4% more volatile than the average stock.

C) 19% more volatile than the average stock.

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Beta is equal to the covariance divided by the market portfolio variance, or the product of the correlation and the ratio of the stock standard deviation to the market standard deviation. To derive the standard deviation, we take the square root of the variance. So beta = 0.67 × 0.479583 / 0.360555 = 0.891183. Glimmer shares are about 11% less volatile than the average stock.

土豆妮

Which of the following statements about using the capital asset pricing model (CAPM) to value stocks is least accurate?

A) If the CAPM expected return is too low, then the asset’s price is too high.

B) The CAPM reflects unsystematic risk using standard deviation.

C) The model reflects how market forces restore investment prices to equilibrium levels.

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The capital asset pricing model assumes all investors hold the market portfolio, and as such unsystematic risk, or risk not related to the market, does not matter. Thus, the CAPM does not reflect unsystematic risk and does not rely on standard deviation as the measure of risk but instead uses beta as the measure of risk. The remaining statements are accurate.

土豆妮

The capital market line:

A) helps determine asset allocation.

B) uses nondiversifiable risk.

C) has a slope equal to the market risk premium.

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The purpose of the CML is to determine the percentages allocated to the market portfolio and the risk-free asset. Both remaining answers reflect characteristics of the security market line.