Scribd
Upload
112 views2 pages

CAPM Portfolio Analysis Exercises

This document contains 5 exercises related to portfolio analysis and the Capital Asset Pricing Model (CAPM). Exercise 1 involves calculating returns and variances of portfolios with different asset allocations. Exercise 2 involves calculating the capital market line given returns and standard deviations of two securities. Exercise 3 involves calculating the standard deviation of a market portfolio given covariance data. Exercises 4 and 5 involve using CAPM concepts to calculate betas, security market lines, and capital market lines for portfolios with multiple assets.

Uploaded by

Nhu Huynh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
112 views2 pages

CAPM Portfolio Analysis Exercises

This document contains 5 exercises related to portfolio analysis and the Capital Asset Pricing Model (CAPM). Exercise 1 involves calculating returns and variances of portfolios with different asset allocations. Exercise 2 involves calculating the capital market line given returns and standard deviations of two securities. Exercise 3 involves calculating the standard deviation of a market portfolio given covariance data. Exercises 4 and 5 involve using CAPM concepts to calculate betas, security market lines, and capital market lines for portfolios with multiple assets.

Uploaded by

Nhu Huynh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Exercise Sheet 7

Exercise 1 Assume there are two stocks, A and B, with A = 1:4 and B =
0:8. Assume also that the CAPM model applies.
(i) If the mean return on the market portfolio is 10% and the risk-free rate
of return is 5%, calculate the mean return of the portfolios consisting of:
a. 75% of stock A and 25% of stock B,
b. 50% of stock A and 50% of stock B,
c. 25% of stock A and 75% of stock B.
(ii) If the idiosyncratic variations of the stocks are A = 4; B = 2 and
the variance of the market portfolio is 2M = 12, calculate the variance of the
portfolios in (a), (b), (c).
(iii) What are the mean return and variance of the portfolios if they are 50%
…nanced by borrowing?

Exercise 2 Assume there are just two risky securities in the market portfolio.
Security A, which constitutes 40% of this portfolio, has an expected return of
10% and a standard deviation of 20%. Security B has an expected return of
15% and a standard deviation of 28%. If the correlation between the assets is
0.3 and the risk free rate 5%, calculate the capital market line.

Exercise 3 The market portfolio is composed of four securities. Given the


following data, calculate the market portfolio’s standard deviation.
Security Covariance with market Proportion
A 242 0.2
B 360 0.3
C 155 0.2
D 210 0.3

Exercise 4 Given the following data, calculate the security market line and the
betas of the two securities.
Expected return Correlation with market portfolio Standard deviation
Security 1 15.5 0.9 2
Security 2 9.2 0.8 9
Market portfolio 12 1 12
Risk free asset 5 0 0

Exercise 5 Consider an economy with just two assets. The details of these are
given below.
Number of Shares Price Expected Return Standard Deviation
A 100 1.5 15 15
B 150 2 12 9
The correlation coe¢ cient between the returns on the two assets if 1/3 and
there is also a risk free asset. Assume the CAPM model is satis…ed.
(i) What is the expected rate of return on the market portfolio?
(ii) What is the standard deviation of the market portfolio?
(iii) What is the beta of stock A?

1
(iv) What is the risk free rate of return?
(vi) Construct the capital market line and the security market line.

Exercise 6 Consider an economy with three risky assets. The details of these
are given below.
No. of Shares Price Expected Return Standard Deviation
A 100 4 8 10
B 300 6 12 14
C 100 5 10 12
The correlation coe¢ cient between the returns on any pair of assets is 1/2
and there is also a risk free asset. Assume the CAPM model is satis…ed.
(i) Calculate the expected rate of return and standard deviation of the market
portfolio.
(ii) Calculate the betas of the three assets.
(iii) Use solution to (ii) to …nd the beta of the market portfolio.
(iv) What is the risk-free rate of return implied by these returns?
(v) Describe how this model could be used to price a new asset, D.

Common questions

Powered by AI

The CML involves plotting returns from 5% (risk-free) to highest portfolio return, while SML plots individual security returns against beta. Determine from asset compositions: E(R_P) = R_f + (σ_P/σ_M)(E(R_M)-R_f) and SML as E(R_i) = R_f + beta_i(E(R_M) - R_f). Calculate variances and covariances for SML/CML points .

CAPM implies that a new asset is priced by determining its expected return through beta: E(R_new) = R_f + beta_new(E(R_M) - R_f). Calculate beta_new from Cov(new, market) using other assets' correlations and historical data. This integrated approach considers systemic risk interplay .

Calculate the expected return using the weighted average of individual asset returns considering their number and price: E(R_M) = [(100*1.5/total value)*15% + (150*2/total value)*12%]. Then calculate standard deviation using sqrt(w_A^2 * σ_A^2 + w_B^2 * σ_B^2 + 2*w_A*w_B*Cov(A,B)), with given sd and correlation (Cov(A,B) = 1/3).

To calculate the portfolio's variance, use the formula: Variance_P = (w_A^2 * Variance_A) + (w_B^2 * Variance_B) + 2(w_Aw_B*Cov(A,B)). Given Variance_A = 4, Variance_B = 2, and Cov(A,B) = beta_A * beta_B * Variance_M = 1.4 * 0.8 * 12, we find: Variance_P = (0.5^2 * 4) + (0.5^2 * 2) + 2(0.5*0.5*13.44) = 9.56 .

Using CAPM E(R_i) = R_f + beta_i(E(R_M) - R_f), solve for R_f. Given stock betas derived and asset expected returns, rearrange for R_f: 15 = R_f + 0.9*(12-R_f) & 9.2 = R_f + 0.8*(12-R_f). Solve these simultaneous equations to find the risk-free rate .

To calculate the mean return of a portfolio consisting of 75% of stock A and 25% of stock B, we use the CAPM formula: Expected Portfolio Return = w_A * E(R_A) + w_B * E(R_B). Given E(R_A) = 1.4 * 0.05 + (1.4 * (0.10 - 0.05)) = 7%, E(R_B) = 0.8 * 0.05 + (0.8 * (0.10 - 0.05)) = 9%, the expected return for the portfolio is (0.75 * 7%) + (0.25 * 9%) = 7.5% .

The CML equation is given by: E(R_P) = R_f + (E(R_M) - R_f)(σ_P/σ_M), where E(R_M) is the expected market return and σ_M its standard deviation. First, calculate E(R_M) and σ_M using weights: w_A = 0.4, w_B = 0.6. E(R_M) = 0.4*10% + 0.6*15% = 13% and σ_M^2 = (0.4^2 * 0.2^2) + (0.6^2 * 0.28^2) + 2*0.4*0.6*0.2*0.28*0.3. Solve for σ_M and plug into the equation to equation to determine the line .

Under CAPM, beta is calculated by: beta_A = Cov(A,M)/Variance_M. Given stock A's expected return 15% and idiosyncratic standard deviation 15, and with variance calculated previously for M, use the relationship between Cov and correlation to find: beta_A = 15/12 * correlation_factor .

The SML is defined by the equation: E(R_i) = R_f + beta_i(E(R_M) - R_f). You calculate beta as Cov(R_i,R_M)/Variance_M. Using expected return E(R_1) = 15.5% correlated at 0.9 with 2% standard deviation, and E(R_2) = 9.2% at 0.8 with 9% standard deviation, solve for beta_1 and beta_2: beta_1 = 0.9(12/2)^-1 and beta_2 = 0.8(12/9)^-1, then plot them according to the given market conditions .

To determine the market portfolio's standard deviation, combine individual security contributions: σ_M^2 = sum(i:1 to 4)(weight_i^2 * Cov(i,M)/weight_i + 2*sum(j>i)(weight_i*weight_j*Cov(i,j)/weight_i*weight_j)). Using given proportions and covariances, plug into σ_M^2 = (0.2^2*242) + (0.3^2*360) + (0.2^2*155) + (0.3^2*210) to find portfolio variance .

You might also like