Question
You are researching two mutual funds, LOW and HIGH. You estimate expected returns for the up-coming year to be 3% for LOW and 21% for
You are researching two mutual funds, LOW and HIGH. You estimate expected returns for the up-coming year to be 3% for LOW and 21% for HIGH. LOW fund invests only in government bonds (risk-free) which it holds to maturity, meaning that LOWs return for the up-coming year is known in advance. HIGH invests in risky securities that give its returns a standard deviation of 64%. To better gauge HIGHs risk, you ran the CAPM regression on some recent historical data: rHI rf = + ( rM rf ) + which generated the following results: Regression Statistics R Square 0.263 Observations 120 Coefficient t Stat Intercept ??? 0.775 (rM rf) 2.050 4.235 You estimate the expected return on the market portfolio to be 11% with standard deviation of 16%. a) Does the HIGH fund lie above, on, or below the Security Market Line? If off, by how much? b) Is HIGH over, under, or fairly-priced according to the CAPM?
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