Discuss the following statement: “The Capital Asset Pricing model (CAPM) has solved all the problems of estimating the relationship between risk and return”.
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Discuss the following statement: “The
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return”.
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- Orb Trust (Orb) has historically leaned towards a passive management style of its portfolios. The only model that Orb’s senior management has promoted in the past is the Capital Asset Pricing Model (CAPM). Now Orb’s management has asked one of its analysts, Kevin McCracken, CFA, toinvestigate the use of the Arbitrage Pricing Theory model (APT).McCracken has determined that a two-factor APT model is adequate where the factors are the sensitivity to changes in real GDP and changes in inflation. McCracken’s analysis has led him to the conclusion that the factor risk premium for real GDP is 8 percent while the factor risk premium for inflation is 2 percent. He estimates for Orb’s High Growth Fund that the sensitivities to these two factors are 1.25 and 1.5 respectively. Using his APT results, he computes the expected return of the fund. For comparison purposes, he then uses fundamental analysis to also computethe expected return of Orb’s High Growth Fund. McCracken finds that the two…Person A, Person B and Person C own stock in the same company. All of them are loss averse and have the same value function: v(x) = x/2 for gains and v(x) = 2x for losses. The stock's price is shown in the graph below (a) 100 90 80 70 60 50 40 30 20 10 0 60 90 Stock Price 95 70 50 October November December January Feburary 80 March Person A bought the stock in November and uses the purchase price as their reference point. If you ask them, how much would they say that they lost in terms of value when the price dropped from £95 to £70? (b) Person B bought the stock in October and uses the peak price as their reference point. If you ask them, how much would they say that they lost in terms of value in January? (c) In January, which month should Person B rather use as reference point in order to maximize their value? (d) [ Person C bought the stock in March. They expect to derive a value of at least +5 in April as compared to their reference point of the purchase price. What is the minimum…Define the term Expected return on a risky asset?
- Black-Scholes Model Use the Black-Scholes model to find the price for a call option with the following inputs: (1) current stock price is $29, (2) strike price is $36, (3) time to expiration is 3 months, (4) annualized risk-free rate is 5%, and (5) variance of stock return is 0.25. Do not round intermediate calculations. Round your answer to the nearest cent. $c. Define Expected Shortfall (ES), which is also called “Conditional Value at Risk (VaR)" or "Expected Tail Loss".The table below shows information for 3 stocks. Security Beta Risk-free rate Expected market return Stock 1 1.9 0.02 0.09 Stock 2 1.2 0.035 0.09 Stock 3 0.2 0.015 0.09 The risk-free rates are different because they were measured in different years. Calculate the expected (or required) return for each stock, using the Capital Asset Pricing Model (CAPM). What is the required return for stock 1? What is the required return for stock 2? What is the required return for stock 3?
- As it captures the sensitivity the price of a financial asset with respect to the fluctuations of the cost of capital, duration can be thought of as a measure of risk, albeit a conditional one. Coherent risk measures should satisfy four conditions, listed on page 260 of your textbook. Show if and how duration satisfies those four conditionsa) Explain the practical relevance of the mean-variance model of portfolio selectionWhat is a Dividend Discount model? What is the main advantage of this model over the Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT) approaches? Explain
- A firm goes to the markets to raise capital. The investor can either invest V₁ on the firm or buy government bonds. If she invests, the expected value of the dividend she receives the following period is Et[Dt+1]. Where Et[] denotes the mathematical expectation, taken at time, t. If she buys a government bond, and receive a gross return (1 + r) for sure. 1. Let Et [Vt+1] denote the expected value of the stock the following period, explain why this is not the only return that the investor can expect from owning the stock. 2. Write down an expression for the gross return on the stock. [Hint: This is a ratio.] 3. Suppose investor's objective is to maximize their expected return. If the return from bonds is higher than the expected return from stocks, will they buy stocks or bonds? How about the other way around? 4. Since investors hold both stocks and bonds, what must be true about the expected return of stocks and bonds in equilibrium? Show that this implies the following no arbitrage…The demand curve and supply curve for one-year discountbonds with a face value of $1,000 are represented by thefollowing equations:Bd: Price = -0.8 * Quantity + 1100Bs: Price = Quantity + 680a. What is the expected equilibrium price and quantityof bonds in this market?b. Given your answer to part (a), what is the expectedinterest rate in this marketThere are only two (equally-likely) states of nature in this economy: boom and bust, which are driven by a common macroeconomic factor F. Asset A & B's payoffs are as shown in the table. Apply APT to obtain factor beta and risk premiums (premia) under no-arbitrage condition. A F Boom (50%) Bust (50%) Price (t=0) 140 135 +1 100 80 -1 105 90 [i] If there is asset Q with its factor beta of 0.66, what is the expected rate of return on asset Q (according to the APT)? 1 [ii] Asset Q should be able to be replicated by a portfolio of asset A & B. What are the percentage weight on asset A and asset B in the Asset Q-replicating portfolio?