Preview

Ugiug

Good Essays
Open Document
Open Document
550 Words
Grammar
Grammar
Plagiarism
Plagiarism
Writing
Writing
Score
Score
Ugiug
3a)
A security with only diversifiable risk has expected return that exceeds the risk-free interest rate.
This statement is inconsistent with both.
Why? Only diversifiable risk implies no undiversifiable (market) risk. Thus, this is a zero-beta security, which is expected to earn the risk- free rate. If it has higher expected return than the risk-free rate, this is not consistent with CAPM. It is above the SML and underpriced, In an efficient market, savy investors would buy this stock pushing its price up, lowering its return. In equilibrium, its expected return should match the required return, i.e. the risk free-rate. If this is not the case markets are not efficient (potentially due to limits in arbitrage)

b)
A security with a beta of 1 had an excess return of 15% last year when the market excess return in the same year was 9%.
This statement is consistent (or is not inconsistent) with both
Why? Realized returns might differ from expected returns due to continuous arrival of new information. If during the year there were good news (i.e. earnings surprises) about the stock, investors could have incorporated this into prices, implying higher than expected returns for the year.

c)
A small stock with beta of 1.5 tends to have higher returns on average than a large stock with a beta of 1.5.
This statement is inconsistent with the CAPM but not necessarily with efficient capital markets.
Why? Beta might not be the correct specification for risk. Small firms might be riskier due to other sources of risk factors (i.e. volatility risk, liquidity risk, business cycle risk, etc.), therefore investors might require higher returns for small stocks taking into account those risk factors.
4)
Describe the three forms of the efficient-market hypothesis.
Weak: The market price of an asset reflects all information contained in the history of past prices - you cannot beat the market by merely analysing past prices.
Semi-strong: The market price of an

You May Also Find These Documents Helpful

  • Good Essays

    The influence of a systematic risk like inflation on a stock by using the beta coefficient. The beta coefficient, ß, tells us the response of the stock's return to a systematic risk. Beta measured the responsiveness of a security's return to a specific risk factor, the return on the market portfolio. The magnitude of the beta describes how great an impact a systematic risk has on a stock's returns. A beta of +1 indicates that the stocks return rises and falls one for one with the systematic factor. Thus, every stock will have a beta associated with each of these systematic risks: an inflation beta, a GNP beta, and an interest-rate…

    • 845 Words
    • 4 Pages
    Good Essays
  • Good Essays

    o The variation in returns is divided into firm risk and market risk. The portion of variations in investment returns that cannot be eliminated through investor diversification. This variation results from factors that affect all stocks.…

    • 659 Words
    • 3 Pages
    Good Essays
  • Good Essays

    E. Risk – The likely variability associated with expected revenue or income streams. With risk prices fluctuate when it comes to securities.…

    • 656 Words
    • 3 Pages
    Good Essays
  • Good Essays

    Hrm/531 Week 9

    • 1413 Words
    • 6 Pages

    1)Most manager are risk-averse, since for a given increase in risk they require an increase in return…

    • 1413 Words
    • 6 Pages
    Good Essays
  • Satisfactory Essays

    Finance Chapter 1-5, 7-10

    • 1966 Words
    • 8 Pages

    | |A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable. | | | |If a stock has a negative beta, its expected return must be negative. | | | |A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5. | | | |According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns. | | | |If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks. | |…

    • 1966 Words
    • 8 Pages
    Satisfactory Essays
  • Satisfactory Essays

    It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm are negative.…

    • 3301 Words
    • 14 Pages
    Satisfactory Essays
  • Good Essays

    For the beta of Papa John’s equity (PZZA), we regressed the monthly return on PZZA with the monthly return on the S&P 500 index. Through doing so, we determined that PZZA had a market beta of 0.53. (Please refer to the attached spreadsheet for calculations of beta.)…

    • 956 Words
    • 4 Pages
    Good Essays
  • Good Essays

    The intuition behind CAPM is that the expected return on a stock is comprised of the risk free rate and the market risk premium. The market risk premium consists of both business risk or the firm’s sensitivity to business cycles and financial risk or the amount of long-term debt the firm carries. The more debt a firm holds the more susceptible to systematic risk the firm will be. For example, higher fixed interest payments will be especially detrimental to the firm during market recessions. The beta on a levered firm reflects both business and financial risk. Thus, CAPM concludes that a stock’s risk premium is beta times the market risk premium. Adding the risk free rate will give us the cost of equity. The firm’s weighted average cost of capital is determined by taking the percentage of equity at market value…

    • 808 Words
    • 3 Pages
    Good Essays
  • Powerful Essays

    Walmart Finacial Analysis

    • 1235 Words
    • 5 Pages

    We use CAPM to calculate the appropriate expected rate of return. Information related to the estimation of Wal-Mart’s beta is presented 0.84. [3] The historical U.S. market risk premium was estimated to be 5.05 percent and the current long-term (10-year) government bond yield was 4.40 percent. The estimation of Wal-Mart’s…

    • 1235 Words
    • 5 Pages
    Powerful Essays
  • Satisfactory Essays

    2. "Describe how different allocations between the risk-free security and the market portfolio can achieve any level of market risk desired." (Cornett, Adair, and Nofsinger, 2012, p. 246).…

    • 519 Words
    • 3 Pages
    Satisfactory Essays
  • Satisfactory Essays

    | E[R] = Rf + Beta × Risk Premium = .04 + 1.1 × (.12 - .04) = .128…

    • 24077 Words
    • 97 Pages
    Satisfactory Essays
  • Satisfactory Essays

    By doing this we assume: the Market risk premium during 2001 would be 6.4%. Acctually, according to the lecturer, the risk premium during year 1998-2008 should be within the range of 4% to 8%. Therefore the assumption of 6.5% seems probable.…

    • 380 Words
    • 2 Pages
    Satisfactory Essays
  • Good Essays

    ufibuwe

    • 749 Words
    • 2 Pages

    The 2005 Kenyon Commencement Address was given by David Foster Wallace, a commencement speaker and a graduating student. DFW states stories that would happen realistically in anyone's lifetime due to the choices of one another. He points out certain flaws that each person has done but didn't realize it. He also explains the rules of patience, everyone has done it and repeats it; your actions influence another's mindset similar to yours and inflicts it on another individual who's innocent of his/her flaws. Although, people bring much negativity in the air, there is still room for positivity and that’s the drive of what keeps people going in life.…

    • 749 Words
    • 2 Pages
    Good Essays
  • Satisfactory Essays

    Investment and Pic

    • 6602 Words
    • 27 Pages

    If Stock Y is less highly correlated with the market than X, then it might have a lower beta than Stock X, and hence be less risky in a portfolio sense.…

    • 6602 Words
    • 27 Pages
    Satisfactory Essays
  • Powerful Essays

    Small Firm Effect

    • 1877 Words
    • 6 Pages

    Small firm effect refers to a situation which the average risk adjusted returns of smaller firms are higher than the larger firms Banz(1981). This situation shows the insufficient of CAPM in predicting the stock returns and counter-argues the efficient market hypothesis Banz(1981). It was found by researching the relationship between the return and market value of common stocks in the New York Stock Exchange. The researchers build a generalized asset pricing model which adds the variable market value of security to the capital assets pricing model Banz(1981). The constant measuring the contribution of market value of a stock to the expected return of the stock was found as a significantly negative number for the all-time period Banz(1981). This indicates that the larger the market values the smaller the expected returns Banz(1981).…

    • 1877 Words
    • 6 Pages
    Powerful Essays