Please show enough work so that it is possible to infer how you arrived at the solution. If applicable, you should write down the equation that allows you to solve the problem. You will lose points if you state the answer without justification.

Questions

1. Suppose that the expected return of the market portfolio is 7% per year and that the risk-free rate is 1%.

(a) What is the expected return of an asset with aof 2 if the CAPM holds?

(b) What is the beta of a portfolio that invests 20% in an asset with a beta of 0.5 and 80% in an asset with a beta of 3?

(c) What is the beta of a portfolio that invests 10% in an asset with a beta of 0.5, 40% in an asset with a beta of 3, and the remaining 50% in the riskless asset?

(d) You analyze an asset that has a beta of 1.5. In your opinion, this asset's expected return is 11%. Is this asset over- or underpriced relative to what the CAPM predicts?

2. Excel workbook CAPMdata.xlsx, which is posted on Blackboard, reports monthly returns from January 2011 through December 2016 for:

(i) General Electric,

(ii) Apple,

(iii) Market portfolio, and

(iv) One-month Treasury bill

(a) What were the (arithmetic) average returns on these four investments during this 72-month period? What were their standard deviations?

Note: Please annualize the average returns by multiplying them by 12 and the standard deviations by multiplying them by ?12 (root of 12). By doing so, you convert the monthly estimates into annual estimates.

(b) Run CAPM regressions to estimate the betas of General Electric and Apple. Report the betas. You only need to write down the estimated betas and describe how you estimated the regression in Excel.

(c) Assuming again that expected return of the market portfolio is 7% per year and that the risk-free rate is 1%, what are your estimates of General Electric's and Apple's expected returns?

Month 201101 201102 201103 201104 201105 201106 201107 201108 201109 201110 201111 201112 201201 201202 201203 201204 201205 201206 201207 201208 201209 201210 201211 201212 201301 201302 201303 201304 201305 201306 201307 201308 201309 201310 201311 201312 201401 201402 201403 201404 201405 201406 General Electric 10.1% 4.6% -4.2% 2.0% -4.0% -3.2% -5.0% -8.9% -5.8% 9.8% -4.8% 13.6% 4.5% 2.7% 5.4% -2.4% -2.5% 10.1% -0.4% -0.2% 10.5% -7.3% 0.3% 0.2% 6.1% 5.1% -0.4% -3.6% 4.6% 0.3% 5.1% -5.0% 4.1% 9.4% 2.0% 6.0% -10.3% 2.2% 1.6% 3.9% -0.4% -1.1% Apple 5.2% 4.1% -1.3% 0.5% -0.7% -3.5% 16.3% -1.4% -0.9% 6.2% -5.6% 6.0% 12.7% 18.8% 10.5% -2.6% -1.1% 1.1% 4.6% 9.4% 0.3% -10.8% -1.2% -9.1% -14.4% -2.5% 0.3% 0.0% 2.3% -11.8% 14.1% 8.3% -2.1% 9.6% 7.0% 0.9% -10.8% 5.7% 2.0% 9.9% 7.8% 2.8% Market 2.0% 3.5% 0.5% 2.9% -1.3% -1.8% -2.4% -6.0% -7.6% 11.4% -0.3% 0.7% 5.1% 4.4% 3.1% -0.9% -6.2% 3.9% 0.8% 2.6% 2.7% -1.8% 0.8% 1.2% 5.6% 1.3% 4.0% 1.6% 2.8% -1.2% 5.7% -2.7% 3.8% 4.2% 3.1% 2.8% -3.3% 4.7% 0.4% -0.2% 2.1% 2.6% One-month T-Bill 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 201407 201408 201409 201410 201411 201412 201501 201502 201503 201504 201505 201506 201507 201508 201509 201510 201511 201512 201601 201602 201603 201604 201605 201606 201607 201608 201609 201610 201611 201612 -4.3% 3.3% -0.5% 0.7% 2.6% -3.7% -5.5% 9.8% -4.5% 9.1% 0.7% -1.7% -1.8% -4.9% 2.5% 14.7% 3.5% 4.8% -6.6% 0.9% 9.1% -3.3% -1.7% 4.9% -1.1% 0.3% -4.4% -1.8% 5.7% 3.5% 2.9% 7.7% -1.7% 7.2% 10.6% -7.2% 6.1% 10.0% -3.1% 0.6% 4.5% -3.7% -3.3% -6.6% -2.2% 8.3% -0.6% -11.0% -7.5% -0.1% 12.7% -14.0% 7.1% -4.3% 9.0% 2.4% 6.6% 0.4% -2.2% 4.8% -2.0% 4.2% -2.0% 2.5% 2.6% -0.1% -3.1% 6.1% -1.1% 0.6% 1.4% -1.5% 1.5% -6.0% -3.1% 7.8% 0.6% -2.2% -5.8% -0.1% 7.0% 0.9% 1.8% 0.0% 4.0% 0.5% 0.3% -2.0% 4.9% 1.9% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Problem Set #3 Instructions: You can complete this problem sets in groups of up to four students. Please show enough work so that it is possible to infer how you arrived at the solution. If applicable, you should write down the equation that allows you to solve the problem. You will lose points if you state the answer without justification. Questions 1. Suppose that the expected return of the market portfolio is 7% per year and that the risk-free rate is 1%. (a) What is the expected return of an asset with a of 2 if the CAPM holds? (b) What is the beta of a portfolio that invests 20% in an asset with a beta of 0.5 and 80% in an asset with a beta of 3? (c) What is the beta of a portfolio that invests 10% in an asset with a beta of 0.5, 40% in an asset with a beta of 3, and the remaining 50% in the riskless asset? (d) You analyze an asset that has a beta of 1.5. In your opinion, this asset's expected return is 11%. Is this asset over- or underpriced relative to what the CAPM predicts? 2. Excel workbook CAPMdata.xlsx, which is posted on Blackboard, reports monthly returns from January 2011 through December 2016 for: (i) General Electric, (ii) Apple, (iii) Market portfolio, and (iv) One-month Treasury bill (a) What were the (arithmetic) average returns on these four investments during this 72month period? What were their standard deviations? Note: Please annualize the average returns by multiplying them by 12 and the standard deviations by multiplying them by 12 (root of 12). By doing so, you convert the monthly estimates into annual estimates. (b) Run CAPM regressions to estimate the betas of General Electric and Apple. Report the betas. You only need to write down the estimated betas and describe how you estimated the regression in Excel. (c) Assuming again that expected return of the market portfolio is 7% per year and that the risk-free rate is 1%, what are your estimates of General Electric's and Apple's expected returns