Question #1: Ch09- CAPM [25 points] Consider the following annualized information about risk and return measures of two

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Question 1 Ch09 Capm 25 Points Consider The Following Annualized Information About Risk And Return Measures Of Two 1 (89.94 KiB) Viewed 28 times

Question #1: Ch09- CAPM [25 points] Consider the following annualized information about risk and return measures of two portfolios. The S&P500 Index portfolio may be viewed as the market portfolio for purposes of applying the CAPM. Portfolio Average Return Standard Deviation Beta Money Market 2% 0% 0.0 Portfolio AA 10% 16% 0.6 Portfolio BB 15% 25% 1.2 S&P500 Index 14% 20% 1.0 (a) Compare the Sharpe Ratio for AA and BB against the market Sharpe Ratio. If the CAPM holds which would you expect to have the larger Sharpe Ratio? (4 marks) (b) Under the assumptions of the CAPM what is the idiosyncratic standard deviation of AA's and BB' returns? (4 marks) (c) Given that the CAPM holds exactly, what is AA's and BB's alphas? (2 marks) (d) Find the correlation between AA's and BB's returns and the S&P500 Index return. (4 marks) (e) What is AA's cost of equity capital based on the CAPM? (4 marks) (f) Explain whether AA's portfolio lies on, below, or above the CML. Show in the graph (2 marks) (g) Explain whether AA and BB portfolios lie on, below, or above the SML. Show in the graph. Do you think that the AA and BB portfolios are underpriced, overpriced, or priced correctly? Explain. (5 marks)