(a) Consider an economy that consists of only two risky stocks, A and B, plus a...

Transcribed Image Text:

(a) Consider an economy that consists of only two risky stocks, A and B, plus a risk- free asset. Assume that the CAPM holds. Data on the two stocks is given in Table 2 below. The correlation between stocks A and B is 0.30. Stock A B Share Price 100 40 Table 2 Shares Outstanding 1,000 2,500 Expected Return 0.250 0.345 Standard Deviation 0.30 0.40 (i) Determine the market portfolio weights of stocks A and B. (ii) Compute the expected return and standard deviation of the market portfolio. (4 marks) (iii) Determine the CAPM beta of each stock. (4 marks) (iv) What is the risk-free rate in this economy? (4 marks) (v) Anaïve investor wants to construct a portfolio that consists of the risk-free asset and stock B so that it has the same standard deviation as the market portfolio. What is the difference in expected return between this new portfolio and the market portfolio? Explain. (6 marks) (4 marks) (b) Are the following propositions true, false, or uncertain? For each statement, first state whether it is true/false/uncertain, then explain your reasoning. You will be assessed on the quality of your explanation. (i) Tesla reported a profit of $270 million for 2020. At the same time, its share price rose by more than 700% in the same year. The fact that the stock market reacted positively to news of positive earnings suggests that it must be informationally efficient. (3 marks) (ii) In a CAPM world, a long put written on a positive beta stock has an expected return that is below the risk-free rate. (4 marks) (iii) Consider two stocks, X and Y, both with identical positive betas. In a CAPM world, a portfolio that is long and short equal dollar amounts in X and Y will have zero systematic risk and hence an expected return equal to the risk-free rate. (5 marks) (a) Consider an economy that consists of only two risky stocks, A and B, plus a risk- free asset. Assume that the CAPM holds. Data on the two stocks is given in Table 2 below. The correlation between stocks A and B is 0.30. Stock A B Share Price 100 40 Table 2 Shares Outstanding 1,000 2,500 Expected Return 0.250 0.345 Standard Deviation 0.30 0.40 (i) Determine the market portfolio weights of stocks A and B. (ii) Compute the expected return and standard deviation of the market portfolio. (4 marks) (iii) Determine the CAPM beta of each stock. (4 marks) (iv) What is the risk-free rate in this economy? (4 marks) (v) Anaïve investor wants to construct a portfolio that consists of the risk-free asset and stock B so that it has the same standard deviation as the market portfolio. What is the difference in expected return between this new portfolio and the market portfolio? Explain. (6 marks) (4 marks) (b) Are the following propositions true, false, or uncertain? For each statement, first state whether it is true/false/uncertain, then explain your reasoning. You will be assessed on the quality of your explanation. (i) Tesla reported a profit of $270 million for 2020. At the same time, its share price rose by more than 700% in the same year. The fact that the stock market reacted positively to news of positive earnings suggests that it must be informationally efficient. (3 marks) (ii) In a CAPM world, a long put written on a positive beta stock has an expected return that is below the risk-free rate. (4 marks) (iii) Consider two stocks, X and Y, both with identical positive betas. In a CAPM world, a portfolio that is long and short equal dollar amounts in X and Y will have zero systematic risk and hence an expected return equal to the risk-free rate. (5 marks)

Answer rating: 100% (QA)

a Lets go step by step to answer each part of the question i To determine the market portfolio weights of stocks A and B we can use the following formula Market Weight of Stock A Market Value of Stock ... View the full answer