FIN30016 5/10/2023

Multiple Choice

Suppose investors believe that the standard deviation of the market-index portfolio has increased by 50%. What does the CAPM imply about the effect of this change on the required rate of return on CBA’s investment projects?

• The required rate of return on a share is related to the required rate of return on the share market via beta. Assuming the beta of CBA remains constant, the increase in the risk of the market will increase the required rate of return on the market and thus increase the required rate of return on CBA.

• There is no effects to the required rate of return on CBA

Multiple Choice

Consider the statement: ‘If we can identify a portfolio that beats the S&P/ASX 200 index portfolio, then we should reject the single-index CAPM. Do you agree or disagree? Explain.

• Disagree. The S&P/ASX 200 may not be a true representation of the market. Therefore, the comparison of the portfolio to the S&P/ASX 200 may not be a valid way to test the CAPM.

• Agree. We don't need CAPM

Multiple Choice

Are the following statements true or false? Explain:

Shares with a beta of zero offer an expected rate of return of zero.

• False. β = 0 implies E(r) = rf , not zero.

• True. Because there is no systematic risk

Multiple Choice

Are the following statements true or false? Explain:

The CAPM implies that investors require a higher return to hold highly volatile

securities.

• False. Investors require a risk premium for bearing systematic (i.e. market or undiversifiable) risk. A high volatility security may have high levels of non-systematic risk, which is unrewarded risk.

• True. High volatility, high return

Multiple Choice

Are the following statements true or false? Explain:

You can construct a portfolio with a beta of 0.75 by investing 0.75 of the budget in T-notes and the remainder in the market portfolio.

• Yes we can! Prove it

• False. You should invest 0.75 of your portfolio in the market portfolio and the remainder in T-bills. Then:

  βP = (0.75 × 1) + (0.25 × 0) = 0.75

Multiple Choice

Assume the risk-free rate is 8% and the expected rate of return on the market is 18% in questions 5–7.

Q5) A share is now selling for $100. It will pay a dividend of $9 per share at the end of the year. Its beta is 1.0. What do investors expect the share to sell for at the end of the year?

• $110

• $109

Multiple Choice

Assume the risk-free rate is 8% and the expected rate of return on the market is 18% in questions 5–7.

Q6) Taren is buying a firm with an expected perpetual cash flow of $1000 but is unsure of its risk. If Taren thinks the beta of the firm is zero, when the beta is really 1.0, how much more will she offer for the firm than it is truly worth?

• $6944.44

• $7449.80

Multiple Choice

Assume the risk-free rate is 8% and the expected rate of return on the market is 18% in questions 5–7.

Q7) A share has an expected return of 6%. What is its beta?

• -0.2

• 0.2

Open Ended

Consider the following data for a single-factor economy. All portfolios are well diversified. Suppose another portfolio E is well diversified with a beta of 2/3 and an expected return of 9%. Would an arbitrage opportunity exist? If so, what would the arbitrage strategy be?