After engaging in the dialogue about the concept of risk and return with your colleagues, you will now be given an opportunity to apply the principles that were presented in this Phase. Using current market data and the capital asset pricing model, determine the required return of the following assets based on the betas provided below. Your mentor suggests using the 5-year U.S. government bond yield as your risk-free rate and the 5-year market return that you calculated in Phase 1.
- Asset A, Beta = 0.5
- Asset B, Beta = 1.0
- Asset C, Beta = 2.0
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Asset
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5-year Risk-Free Rate of Return
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Beta (β) (Given)
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5-Year Return on Top 500 Stocks
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Required Return on Investment
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Asset 'A'
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0.50
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Asset 'B'
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1.00
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Asset 'C'
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2.00
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After completing your calculations, summarize your observations with regard to the relationship between risk and return based on the results of this experiment.
For Part 2 of this task, you will need to select 3 mutual funds with different betas and use the capital asset pricing model to approximate the 5-year minimum required return for each of these funds based on their individual betas. After you calculate the 5-year required return, you can now compare it to the actual 5-year returns of these funds and determine whether they are over- or underperforming.
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Symbol of Mutual Fund
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5-year Risk-Free Rate of Return
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Mutual Fund Betas (β)
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5-Year Return on Top 500 Stocks
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Required Return on Investment
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Actual Return
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Performance
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In your writeup associated with this activity, be sure to present and explain your results as they relate to risk and return, and explain the following:
- Why mutual fund investing is generally considered less risky than purchasing individual assets?
- How are the CAPM and the SML related and can be used to identify over- and underperforming investments?
- How do inflationary expectations and the markets' perception of risk affect the slope and origin of the SML?