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 1 (118.9 KiB) Viewed 21 times

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(r) = 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]