Before starting these exercises, be sure to work through the examples in the notes and from the chapter!   

Chapt 7 # 3,6,8-14,15, 16.  

3.  Use the CAPM relationship to verify that the beta of the portfolio is 1.5.

8.  These data are not consistent with the CAPM.  The CAPM indicates that portfolios with higher beta have higher expected returns.

9.  These data are possibly consistent with the CAPM, since the CAPM does not offer guidance on the relationship between expected return on any two random portfolios.

10.  These data are not consistent with the CAPM, since the reward-to-variability ratio for the market portfolio (  (18%-10%) / 24% = 1/3)  is less than the reward-to-variability ratio from portfolio A (1/2).   Recall that the reward-to-variability ratio is:   (E(r_p) - r_f) / sigma_p  

 11.  These data are not consistent with the CAPM, since the reward-to-variability ratio for the market portfolio (  (18%-10%) / 24% = 1/3)  is less than the reward-to-variability ratio from portfolio A (5/11).  You can actually see this readily because portfolio A has both higher expected return and lower std deviation than the market.

12.   These data are not consistent with the CAPM.  Given the returns on the risk-free rate and the market portfolio, the CAPM predicts that a portfolio with a beta of 1.5 will have an expected return of 22%.  That is, the CAPM says:  E(r_p) = r_f + beta*[E(r_m) - r_f] = 10% + 1.5 [18%-10%] = 22%.

13.   These data are not consistent with the CAPM.  Given the returns on the risk-free rate and the market portfolio, the CAPM predicts that a portfolio with a beta of 0.9 will have an expected return of 17.2%.  That is, the CAPM says:  E(r_p) = r_f + beta*[E(r_m) - r_f] = 10% + 0.9 [18%-10%] = 17.2%.

14.  Based on reward to variability ratios, these data are possible under the CAPM.

15.  Calculate regression in Excel!!

16.  Since the expected return on the market is 18%, any stock with a beta of 1 will also have an expected return of 18%, under the CAPM.  If a stock currently trades for $100, then a dollar return of $18 over one year is required.  If $9 is paid by dividends, then the final stock price must by $109.


OTIS:  Look up the betas of your indiv stocks at http://moneycentral.msn.com, http://finance.yahoo.com or http://www.reuters.com. (The MSN stie should currently be reporting betas.  The Reuters site may ask you to register -- registration is currently free. The Yahoo site stopped reporting betas for a while, but is reported them again)  Use this data, along with the percent invested in each stock, to calculate the beta of your equity portfolio (recall that the beta of your equity portfolio is a weighted avgerage of the stock's betas).  You may want to do this in a spreadsheet, to make the calculation easier.  Is the beta consistent with your expectations and objectives?  Describe why or why not.
Record your calculations and statement in your OTIS "journal".


Note: Ignore amounts invested in cash or bonds in the calculation of the beta for your equity portfolio.  For example, if you have $800k invested in stocks (with $100k in AAPL) and $200k in cash, then the portfolio weight for AAPL in your equity portfolio is $100k/$800k = 12.5%.

One group member must now submit your OTIS Journal (one MS Word File) to Blackboard, on the day this chapter assignment is due in class.
Go to the blackboard page for this class and look for the link to submit under "Assignments".  Rename your file so that it has the last name of each group member seperated by an "_".  For example, the name of the file should be something like "Elder_Smith_Jones.doc"