1.Consider the one-factor APT. The standard deviation of return on a well-diversified portfolio is 20%. The standard deviation on the factor portfolio is 12%. The beta of the well-diversified portfolio is approximately _________.

2.According to the CAPM, what is the expected market return given an expected return on a security of 15.8%, a stock beta of 1.2, and a risk-free interest rate of 5%?

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andromache andromache · Answer 1 · 2019-11-21T07:05:21+01:00

Answer:

The beta of the well-diversified portfolio is approximately is 1.67

Market rate of return is 14%

Explanation:

The computation of the beta is shown below:

= Standard deviation of return on a well-diversified portfolio ÷ standard deviation on the factor portfolio

= 20% ÷ 12%

= 1.67

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

Expected rate of return = Risk-free rate of return + Beta × (Market rate of return - Risk-free rate of return)

15.8% = 5% + 1.2 × (Market rate of return - 5%)

10.8% = 1.2 × (Market rate of return - 5%)

10.8% ÷ 1.2 = (Market rate of return - 5%)

9% = Market rate of return - 5%

So, the market rate of return equals to

= 9% + 5%

= 14%