RISK-RETURN CAPM 1. Measures of Return 2. Definition of Risk Risk Measurement 1-Risk of an Asset in Isolation Standard deviation Coefficient of variation

2-Portfolio of Two Assets Correlation coefficient and Covariance

3-Risk of an Asset as part of a Diversified Portfolio Systematic (Market) and unsystematic (Diversifiable) risk CAPM and beta Risk Return Problems 1-Given the large-cap stock index and the government bond index data in the following table, calculate the expected mean return and standard deviation of return for a portfolio 75 percent invested in the stock index and 25 percent invested in the bond index. Large Cap Stock Index Government Bond Index

Large Cap Stock Index Government Bond Index

Expected Return 15% 5%

Standard Deviation 15% 10% Correlation 0.5

2-Suppose the expected return on stock A is 18% and Stock B is 23%. The correlation between the two stocks is 0.1. The standard deviation of A is 40% and of B is 50%. What is the expected return and the standard deviation of an equally weighted portfolio of A and B?

3-Assume the expected return on stocks is 18% (represented by Z in the graph), and the expected return on bonds is 8% (represented by Y). The graph shows the portfolio possibilities curve for stocks and bonds. a) Which point on the graph represents a 90% allocation in stocks and a 10% allocation in bods? b) Which part of the graph is the efficient frontier? c) What happens to the shape of this graph if short sale is allowed?

4-A Company's stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the required rate of return?

5-A stock has a required return of 12.60%. Its beta is 1.49 and the risk-free rate is 5.00%. What is the market risk premium?

6-The market return based on a broad market index is calculated as 15%. Calculate a companys required return if the risk free rate is 4% and the stocks beta is 1.35.

7-You want to invest $100,000 in two mutual funds: US Small cap equity index fund and US long-term government bond index fund. The table provides monthly historical returns for the past 20 years. Asset Class Average Return Standard Deviation US Small Cap 14.63% 22.18% US government bond 9.55% 9.8% Correlation 0.15 Find the Expected return and standard deviation for the allocation of 60% in stocks and 40% in bonds. Find the range of possible allocations. What is the maximum return? What is the minimum risk?