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Reading 51: An Introduction to Asset Pricing Models - LOS

Q22. Luis Green is an investor who uses the security market line to determine whether securities are properly valued. He is evaluating the stocks of two companies, Mia Shoes and Video Systems. The stock of Mia Shoes is currently trading at $15 per share, and the stock of Video Systems is currently trading at $18 per share. Green expects the prices of both stocks to increase by $2 in a year. Neither company pays dividends. Mia Shoes has a beta of 0.9 and Video Systems has a beta of (-0.30). If the market return is 15% and the risk-free rate is 8%, which trading strategy will Green employ?

Mia Shoes         Video Systems

A)  Buy                     Sell

B)  Buy                    Buy

C)  Sell                    Buy

Q23. Given a beta of 1.25 and a risk-free rate of 6%, what is the expected rate of return assuming a 12% market return?

A)   13.5%.

B)   10%.

C)   31%.

Q24. The expected rate of return is 1.5 times the 16% expected rate of return from the market. What is the beta if the risk free rate is 8%?

A)   2.

B)   3.

C)   4.

Q25. Consider the following graph of the Security Market Line (SML). The letters X, Y, and Z represent risky asset portfolios. The SML crosses the y-axis at the point 0.07. The expected market return equals 13.0%. Note: The graph is NOT drawn to scale.

Using the graph above and the information provided, which of the following statements is most accurate?

A)   The expected return (or holding period return) for Portfolio Z equals 14.8%.

B)   Portfolio Y is undervalued.

C)   Portfolio X's required return is greater than the market expected return.

 

答案和详解如下:

Q22. Luis Green is an investor who uses the security market line to determine whether securities are properly valued. He is evaluating the stocks of two companies, Mia Shoes and Video Systems. The stock of Mia Shoes is currently trading at $15 per share, and the stock of Video Systems is currently trading at $18 per share. Green expects the prices of both stocks to increase by $2 in a year. Neither company pays dividends. Mia Shoes has a beta of 0.9 and Video Systems has a beta of (-0.30). If the market return is 15% and the risk-free rate is 8%, which trading strategy will Green employ?

Mia Shoes         Video Systems

A)  Buy                     Sell

B)  Buy                    Buy

C)  Sell                    Buy

Correct answer is C)

The required return for Mia Shoes is 0.08 + 0.9 × (0.15-0.08) = 14.3%. The forecast return is $2/$15 = 13.3%. The stock is overvalued and the investor should sell it. The required return for Video Systems is 0.08 - 0.3 × (0.15-0.08) = 5.9%. The forecast return is $2/$18 = 11.1%. The stock is undervalued and the investor should buy it.

Q23. Given a beta of 1.25 and a risk-free rate of 6%, what is the expected rate of return assuming a 12% market return?

A)   13.5%.

B)   10%.

C)   31%.

Correct answer is A)

k = 6 + 1.25 (12 − 6)

= 6 + 1.25(6)

= 6 + 7.5

= 13.5

Q24. The expected rate of return is 1.5 times the 16% expected rate of return from the market. What is the beta if the risk free rate is 8%?

A)   2.

B)   3.

C)   4.

Correct answer is A)

24 = 8 + β (16 − 8)
24 = 8 + 8β
16 = 8β
16 / 8 = β
β = 2

Q25. Consider the following graph of the Security Market Line (SML). The letters X, Y, and Z represent risky asset portfolios. The SML crosses the y-axis at the point 0.07. The expected market return equals 13.0%. Note: The graph is NOT drawn to scale.

Using the graph above and the information provided, which of the following statements is most accurate?

A)   The expected return (or holding period return) for Portfolio Z equals 14.8%.

B)   Portfolio Y is undervalued.

C)   Portfolio X's required return is greater than the market expected return.

Correct answer is A)

At first, it appears that we are not given the information needed to calculate the holding period, or expected return (beginning price, ending price, or annual dividend). However, we are given the information required to calculate the required return (CAPM) and since Portfolio Z is on the SML, we know that the required return (RR) equals the expected return (ER). So, ER = RR = Rf + (ERM – Rf) × Beta = 7.0% + (13.0% − 7.0%) × 1.3 = 14.8%.

The SML plots beta (or systematic risk) versus expected return, the CML plots total risk (systematic plus unsystematic risk) versus expected return. Portfolio Y is overvalued – any portfolio located below the SML has an RR > ER and is thus overpriced. Since Portfolio X plots above the SML, it is undervalued and the statement should read, “Portfolio X’s required return is less than the market expected return.”

 

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