honeycfa

An investor is considering an investment. After a great deal of careful research he determines that the forecasted return on the investment is 15% and estimates the beta to be 2.0. The risk-free rate of interest is 3%, and the return on the market is 13%. Should the project be undertaken?

A) Yes, the forecasted return is less than the expected return of 18%.

B) No, the forecasted return is less than the expected return of 23%.

C) Yes, the forecasted return is more than the expected return of 13%.

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Per the Capital Asset Pricing Model (CAPM), the expected rate of return = R_f + b[E(R_m) – R_f]> >= 3 + 2(13.0 ? 3.0) = 23%.> >

Since the forecated return of 15% is less than expected rate of return of 23%, the investment should not be undertaken.> >

honeycfa

The market is expected to return 12% next year and the risk free rate is 6%. What is the expected rate of return on a stock with a beta of 0.9?

A) 13.0.

B) 11.4.

C) 10.8.

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ER_stock = R_f + ( ER_M ? R_f ) Beta_stock.

honeycfa

Figment, Inc., stock has a beta of 1.0 and a forecast return of 14%. The expected return on the market portfolio is 14%, and the long-run inflationary expectation is 3%. Which of the following statements is most accurate? Figment, Inc.’s stock:

A) valuation relative to the market cannot be determined.

B) is overvalued.

C) is properly valued.

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Since Figment, Inc.’s, stock has a beta equal to 1.0, then the expected return of this stock is equal to the expected return on the market portfolio, which also has a beta of 1.0. Since Figment’s expected return is equal to its required return, the stock is properly valued.

honeycfa

Callard Corp. stock has a beta of 1.5. If the current risk-free interest rate is 6%, and the expected return on the market is 14%, what is the expected rate of return for Callard Corp.’s stock?

A) 18%.

B) 20%.

C) 14%.

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ER_cc = 0.06 + 1.5(0.14 ? 0.06) = 18%

honeycfa

Which of the following is NOT a prediction of the capital asset pricing model (CAPM)?

A) All investors hold an equally weighted market portfolio of all assets.

B) All investors identify the same risky tangency portfolio and combine it with the risk-free asset to create their own optimal portfolios.

C) The market price of risk is the slope of the capital market line.

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The CAPM predicts that all investors hold the market portfolio - a portfolio in which each asset is held in proportion to its market value. This portfolio is value-weighted, not equally weighted. The capital allocation line is then the capital market line (CML) and the market price of risk is the slope of the CML. The security market line (SML) describes the relationship between asset risk and expected return, where risk is measured by beta.

honeycfa

According to the capital asset pricing model (CAPM), if the expected return on an asset is too high given its beta, investors will:

A) sell the stock until the price falls to the point where the expected return is again equal to that predicted by the security market line.

B) buy the stock until the price rises to the point where the expected return is again equal to that predicted by the security market line.

C) buy the stock until the price falls to the point where the expected return is again equal to that predicted by the security market line.

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The CAPM is an equilibrium model: its predictions result from market forces acting to return the market to equilibrium. If the expected return on an asset is temporarily too high given its beta according to the SML (which means the market price is too low), investors will buy the stock until the price rises to the point where the expected return is again equal to that predicted by the SML.