CAS Exam 9 Spring 2019, Question 4
Study guide: Exam 9
Given the following information:
- Covariance Matrix:
| Market | Stock A | Stock B | Stock C | |
|---|---|---|---|---|
| Market | 0.200 | |||
| Stock A | 0.170 | 0.342 | ||
| Stock B | 0.280 | 0.238 | 0.653 | |
| Stock C | 0.240 | 0.204 | 0.336 | 0.450 |
- Risk-Free Rate = 5.0%
- Market Price of Risk = 42.5%
- A portfolio manager uses a unique input list and calculates the following forecasted returns:
| Forecasted Return | |
|---|---|
| Stock A | 10.5% |
| Stock B | 18.7% |
| Stock C | 15.2% |
Part a (1.5 points)
Calculate the expected return of the market and each of the 3 stocks under CAPM.
Part b (1.25 points)
Plot the Security Market Line. On the graph include:
- i. The market portfolio
- ii. The CAPM expected return for each stock
- iii. The forecasted return for each stock
Part c (1.25 points)
The portfolio manager recommends investing in the stock with the largest \alpha. The portfolio manager's client has a utility function of U = \text{Forecasted Return} - 0.2\sigma^2 and wants to invest in a single stock. Recommend and fully justify a stock for the client.
No current syllabus covers this question; it is kept for the record.
Answer this question and see the worked solution