QUESTION 21

Questions 21 & 22

Advisor also specializes in providing advice to clients about their overall asset allocation strategy. For all of his clients, Andy manages portfolios that lie on the efficient frontier. Caleb asks Andy to review the two new portfolios that UMB launched last week. Newton Portfolio and Boston Portfolio. The expected returns of the two portfolios are significantly different. Using the assumptions of capital market theory, Andy determines that the Newton portfolio is the market portfolio. Andy made the following statements about two portfolios. Statement -3: Based on the capital market line, Newton portfolio is superior to the Boston portfolio. Statement -4: Newton portfolio has a higher expected return because it has greater unsystematic risk than Bostons portfolio. With respect to his statements 3 and 4 is Andy correct?

A. Yes for statement 3 and No for statement 4 B. No for statement 3 and Yes for statement 4 C. Neither statement 3 nor statement 4 is correct 1 points Save Answer

QUESTION 22

In response to a Caleb question regarding Capital Market Line and Market portfolio, Andy give the following example. Example: Newton Portfolio, the market portfolio, has an expected return of 12 percent and a standard deviation of 19 percent. The risk free rate is 5 percent. Using the data in the example and the Capital market theory, Andy made following statements: Statement 5: Based on the information in the example, If Boston portfolio is a well-diversified portfolio and has a standard deviation of 7 percent, the expected return on a well-diversified Boston portfolio would be 7.58%. Statement 6: Based on the information in the example, If Boston portfolio is a well-diversified portfolio and has an expected return of 20 percent, the standard deviation of a well-diversified Boston Portfolio would be 40.71%. Is Andy correct with respect to his statements 5 and 6?

A. No. B. Yes, because the slope of the Capital Market Line is 0.368 C. Yes, because the standard deviation of the well-diversified Boston portfolio is 7.58% 1 points Save Answer

QUESTION 23

Questions 23 & 24 Moonn is evaluating the expected performance of two common stocks, Harvard, Inc. and Yale, Inc. She has gathered the following information. However, Moonn was not sure which model would be appropriate to value these stocks. Caleb tells Moonn that she should use the Capital Asset Pricing (CAPM)/security market line equation to determine the performance of Harvard, Inc. and Yale, Inc and made the following statement regarding CAPM: The CAPM is an equation for required return that should hold in equilibrium (the condition in which supply equals demand) if the models assumptions are met; among the key assumptions are that investors are risk averse and that they make investment decisions based on the mean return and variance of returns of their total portfolio. The chief insight of the model is that investors evaluate the risk of an asset in terms of the assets contribution to the systematic risk of their total portfolio (systematic risk is risk that cannot be shed by portfolio diversification). Because the CAPM provides an economically grounded and relatively objective procedure for required return estimation, it has been widely used in valuation. The risk-free rate 5 percent The expected return on the market portfolio 11.5 percent The beta of Harvard stock 1.5 The beta of Yale stock 0.8. Andys forecasts of the returns on the Harvard stocks 13.25 percent Andys forecasts of the returns on the Yale stocks 11.25 percent Moon made the following statements regarding the Harvard stock and Yale stock. Statement 7: Using the Security Market Line (SML) equation, I believe both Harvard and Yale stocks are overvalued. With respect to statement 7, Moonn is incorrect:

A. Because CAPM return is 10.20% and the Yale stock is overvalued B. Because CAPM return is 14.75% and the Harvard stock is undervalued. C. Because CAPM return is 10.20% and the Yale stock is undervalued.

QUESTION 24

Is Caleb correct with respect to his statement regarding CAPM?

A. Yes. B. No, he is only correct regarding systematic risk risk that cannot be shed by portfolio diversification. C. No, because investors are not risk averse and that they do not make investment decisions based on the mean return and variance of returns of their total portfolio.