Question

Consider the following information: Portfolio Expected Return Beta Risk-free 5 % 0 Market 10.6 1.0 A 8.6 0.9 a. Calculate the expected return of portfolio A with a beta of 0.9. (Round your answer to 2 decimal places.) b. What is the alpha of portfolio A. (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.) c. If the simple CAPM is valid, is the above situation possible?

Answer 1

Answer:

a. Expected return of portfolio A = 10.04%

b. Alpha of portfolio A = 1.44%

c. No, the above situation is NOT possible. This is because return as per CAPM and expected return have different values. Therefore, we say that CAPM is NOT valid.

Explanation:

Given:

Portfolio           Expected Return       Beta

Risk-free                     5  %                     0

Market                     10.6                       1.0

A                               8.6                       0.9

a. Calculate the expected return of portfolio A with a beta of 0.9. (Round your answer to 2 decimal places.)

Expected return of portfolio A = Return as per CAPM = Risk free rate + (Beta * (Market return - Risk free rate)) = 5% + (0.9 * (10.6% - 5%)) = 10.04%

b. What is the alpha of portfolio A. (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

Alpha of portfolio A = Return as per CAPM - Expected return = 10.04% - 86% = 1.44%

c. If the simple CAPM is valid, is the above situation possible?

No, the above situation is NOT possible. This is because return as per CAPM and expected return have different values. Therefore, we say that CAPM is NOT valid.