The following shows a single-index pricing model for an asset X. ex is the error term...

Transcribed Image Text:

The following shows a single-index pricing model for an asset X. ex is the error term from regression. RM is the excess return of the market portfolio. Rx is the excess return of the asset X. Rx = ax + 3x RM + ex It is given that ox=0.8 and M = 0.8. The risk-free rate is 1% (a) If CAPM model predicts perfectly, and RM = 9%, i. (2 points) What is a and ex? Explain. ii. (1 point) Find the value of Rx if 3x = 2. iii. (2 points) Find the correlation coefficient between Rx and RM if 3x = 2. (b) In this part, you should not assume CAPM model being true. Here 3x = 2. i. (2 points) If E(Rx) = 5% when E(RM) = 3%, find the alpha of asset X. Hence, is it a good-buy? Why or why not? ii. (2 points) If an SML is needed to draw with M as the market portfolio, what is the slope of the SML? iii. (2 points) Try to draw an SML and show the position of X and M. iv. (4 points) A portfolio consisting of 40% of X and 60% of M is formed. Find the expected return and volatility of this portfolio. The following shows a single-index pricing model for an asset X. ex is the error term from regression. RM is the excess return of the market portfolio. Rx is the excess return of the asset X. Rx = ax + 3x RM + ex It is given that ox=0.8 and M = 0.8. The risk-free rate is 1% (a) If CAPM model predicts perfectly, and RM = 9%, i. (2 points) What is a and ex? Explain. ii. (1 point) Find the value of Rx if 3x = 2. iii. (2 points) Find the correlation coefficient between Rx and RM if 3x = 2. (b) In this part, you should not assume CAPM model being true. Here 3x = 2. i. (2 points) If E(Rx) = 5% when E(RM) = 3%, find the alpha of asset X. Hence, is it a good-buy? Why or why not? ii. (2 points) If an SML is needed to draw with M as the market portfolio, what is the slope of the SML? iii. (2 points) Try to draw an SML and show the position of X and M. iv. (4 points) A portfolio consisting of 40% of X and 60% of M is formed. Find the expected return and volatility of this portfolio.

Answer rating: 100% (QA)

a i If CAPM predicts perfectly then alphaX 0 intercept should be 0 eX 0 error term should b... View the full answer