Assignment : Risk, Return, and Capital Asset Pricing Model Problems
In this assignment, assume that you are nearing graduation and applying for a job with a financial services firm. As part of the evaluation process, you are asked to provide answers to a series of questions on risk return and the capital asset pricing model. Your responses will be based on the data for Company A and Company B below.
|
Year
|
Company A's Return
|
Company B's Return
|
Average Market Return
|
|
1995
|
5.0%
|
4.0%
|
2.0%
|
|
1996
|
4.0%
|
-8.0%
|
6.0%
|
|
1997
|
3.0%
|
2.0%
|
7.0%
|
|
1998
|
4.0%
|
5.0%
|
8.0%
|
|
1999
|
8.0%
|
3.0%
|
9.0%
|
|
2000
|
5.0%
|
4.0%
|
10.0%
|
|
2001
|
4.0%
|
1.0%
|
11.0%
|
|
2002
|
4.0%
|
8.0%
|
10.0%
|
|
2003
|
4.0%
|
9.0%
|
9.0%
|
|
2004
|
7.0%
|
10.0%
|
8.0%
|
|
2005
|
8.0%
|
-2.0%
|
7.0%
|
|
2006
|
9.0%
|
7.0%
|
6.0%
|
|
2007
|
10.0%
|
5.0%
|
5.0%
|
|
2008
|
7.0%
|
4.0%
|
6.0%
|
|
2009
|
-4.0%
|
2.0%
|
7.0%
|
|
2010
|
-5.0%
|
11.0%
|
8.0%
|
Procedure
1. For each company,
- Determine the mean and standard deviation of the returns.
- Calculate the coefficient of variation.
- Determine which company appears to be more volatile with respect to its risk.
- Identify the company with which you would choose to invest.
2. Using the CAPM, compute the expected return rate of return for Companies A and B. Assume a Market Risk Premium of 3%, a Risk-Free Rate of 4%, a Beta for company A of .90 and a Beta for company B of 1.3.
3. Using the CAPM, compute the expected rate of return for a portfolio with 25% stake in company A and a 75% stake in company B. Assume a Market Risk Premium of 3% and a Risk-Free Rate of 4%.