27/12/2021
Jerry Alan graduated from the University of Texas with a finance degree in the spring of
2016 and took a job with a Houston-based investment banking firm as a financial analyst.
One of his first assignments is to investigate the expected rates of return for three technology
stocks: Apple (APPL), Microsoft (MS) and Hewlett Packard (HP). Jerry’s supervisor
suggests that he make his estimates using the Capital Asset Pricing Model (CAPM),
assuming the risk–free rate is 4.5 percent and the expected return on the market portfolio is
10.5 percent. The information for the stocks as follows:
Stocks Beta Portfolio (%) Expected Return
(%)
APPL 2.0 30,000 18
MS 1.5 50,000 20
HP 0.5 20,000 6
100,000
Required:
a) Calculate the required rate of return for each stock by using the CAPM.
[CLO1:PLO1:C1](3 marks)
k = rf + β(rm – rf)
kAPPL = 4.5% + 2(10.5%-4.5%) = 16.5%
kMS = 4.5% + 1.5(10.5%-4.5%) = 13.5%
kHP = 4.5% + 0.5(10.5%-4.5%) = 7.5%
b) Plot each of the stock on the Security Market Line (SML).
[CLO1:PLO1:C2](5 marks)
c) Calculate the alpha and draw in the graph for each stock.
[CLO1:PLO1:C1](3 marks)
d) Draw the slope in the SML and calculate the slope.
[CLO1:PLO1:C2](2 marks)
e) Find the expected return portfolio and beta portfolio and plot in the graph.
f) Calculate the risk premium and show in the graph.
g) Comment your outcome from (c).
[CLO1:PLO1:C3](5 marks)
Jerry Alan graduated from the University of Texas with a finance degree in the spring of
2016 and took a job with a Houston-based investment banking firm as a financial analyst.
One of his first assignments is to investigate the expected rates of return for three technology
stocks: Apple (APPL), Microsoft (MS) and Hewlett Packard (HP). Jerry’s supervisor
suggests that he make his estimates using the Capital Asset Pricing Model (CAPM),
assuming the risk–free rate is 4.5 percent and the expected return on the market portfolio is
10.5 percent. The information for the stocks as follows:
Stocks Beta Portfolio (%) Expected Return
(%)
APPL 2.0 30,000 18
MS 1.5 50,000 20
HP 0.5 20,000 6
100,000
Required:
a) Calculate the required rate of return for each stock by using the CAPM.
[CLO1:PLO1:C1](3 marks)
k = rf + β(rm – rf)
kAPPL = 4.5% + 2(10.5%-4.5%) = 16.5%
kMS = 4.5% + 1.5(10.5%-4.5%) = 13.5%
kHP = 4.5% + 0.5(10.5%-4.5%) = 7.5%
b) Plot each of the stock on the Security Market Line (SML).
[CLO1:PLO1:C2](5 marks)
c) Calculate the alpha and draw in the graph for each stock.
[CLO1:PLO1:C1](3 marks)
d) Draw the slope in the SML and calculate the slope.
[CLO1:PLO1:C2](2 marks)
e) Find the expected return portfolio and beta portfolio and plot in the graph.
f) Calculate the risk premium and show in the graph.
g) Comment your outcome from (c).
[CLO1:PLO1:C3](5 marks)
