4. John is a financial engineer who has developed an asset pricing model. Like generally accepted pricing models, John’s

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4. John is a financial engineer who has developed an asset
pricing model. Like generally accepted pricing models, John’s model
predicts a relationship between risk and expected return. However,
John’s model uses something called Zen (represented by the variable
𝑍 in John’s writings) as a risk measure. Only John understands how
to calculate Zen, but John claims to have proven that, for any
stock, 𝐸(𝑟𝑖 ) = 3𝑍. The following table provides data for five
stocks, including actual return, Zen, and beta. Stock Zen Beta
Actual Return A 0.08 2.00 32.0% B 0.24 1.75 32.0 C 0.07 1.20 24.0 D
0.04 0.50 12.0 E 0.03 0.25 8.5
a. For each stock, calculate the expected return according to
John’s model and the CAPM. The expected return on the market is
20%, and the risk-free rate is 4%. [15 marks]
b. For each stock, use both pricing models to determine whether
or not the stock earned an abnormal return. Show whether the
abnormal return is positive, negative, or zero. [15
marks]
c. What does this problem reveal about the real-world
difficulties of determining whether the market is efficient?
[20 marks]