Assignment 1: Risk, Return, and Capital Asset Pricing Model Problems
In this assignment, suppose 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 problems 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,
a. Find out the mean and standard deviation of the returns.
b. Compute the coefficient of variation.
c. Find out which company appears to be more volatile with respect to its risk.
d. 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. Suppose a Market Risk Premium of 3% and a Risk-Free Rate of 4%.