Risk and return relationship, capital asset pricing model (CAPM) and arbitrage pricing theory (APT) Discuss the following issues and solve the following problems. It is recommended that you use a spreadsheet (Excel) for your calculations and graphs. Questions Define and discuss the following notion Attainable set Efficient frontier, Risk free rate. Market portfolio. Discuss the assumptions of the CAPM Define the beta coefficient 2 3. 4 Explain the capital market line and security market line. $ What is the characteristic line of a security? 6. Explain the law of one price-the underlying assumption of arbitrage pricing theory. 1 Problem The security market line (SML) The Mitchell Investment Fund has total capital of 400 million. It is currently invested in five stocks: Stock Investment Beta (mil) A 120 0.5 B 100 20 C 60 4.0 D 80 1.0 E 40 3.0 a) b) Calculate the beta coefficient of the fund frid Risk-free rate is now 7 per cent (R-7%) and expected market return is 12 per cent (R-12%). Calculate the expected return of the fund Ar c) Draw the security market line (SML) of the fund portfolio. d) e) Now suppose that another 50 mil. have been invested into the fund. John Mitchell-president of the fund-receives an offer to invest this money in a new stock G. John Mitchell was told, that the stock has retum 16 per cent p.a. (-16%), and risk f-2.5. Should the new stock be purchased? At what expected rate of retum should Mitchell agree to purchasing the stock G? Assume that the fund manager decides to invest 50 mil into another asset H instead of G. This asset H has risk fl-2.5 and return k-19.5 per cent p.a. Will this investment have an impact on the risk of the fund portfolio Will it modify the expected return of this portfolio Ar? How will the SML of the portfolio be modified?