MBA HEC Paris

Financial Markets Philippe Henrotte

Practice 3

CAPM

For all numerical questions in this homework where a rate, a return, a correlation, a
Beta value or a standard deviation is requested, give your answer as a number with 4 digit
precision, for instance enter 0.1234 if your answer is 12.34%.

Question 1. (1 point) Following CAPM, can the Tangent Portfolio possibly include any
short position on some risky security?

Question 2. (1 point) Stock A has a Beta of 2.3 while Stock B has a Beta of 0.70. The
risk free rate is 2% and the expected return of the Market Portfolio is 8%. What is the
expected return of a portfolio that consists of 65% of Stock A and 35% of Stock B according
to CAPM?

Question 3. (1 point) Ms Smith and Mr Johns have both invested in a mean variance
efficient way and CAPM holds. Mr Smith’s portfolio has an expected return of 13% and a
volatility of 20% while Ms Smith’s portfolio has an expected return of 20% and a volatility
of 34%. What is the risk free rate?

Question 4. (1 point) A stock has an expected return lower than the risk free rate and a
large volatility. Is this compatible with the CAPM?

Question 5. (1 point) The return of the Market Portfolio has an expected value of 10%
and a standard deviation of 25%. The CAPM holds and the risk free rate is 5%. The stock
XYZ has an expected return of 8% with 50% standard deviation. What is the correlation
between the return of stock XYZ and the return of the Market Portfolio?

1
 Problem 1. First Portfolio (3 points)

As your first portfolio investment, you decide to only invest in two stocks. You short
USD 20, 000, 000 worth of Oracle stock and you purchase USD 60, 000, 000 of Intel stock.
The correlation between Oracle’s and Intel’s returns is 0.7 and the expected returns and
standard deviations of the two stocks are given in the table below.

Expected Return Standard Deviation

Oracle 12.00% 45.00%
Intel 14.50% 40.00%

Question 6. (1 point) What is the expected return of your portfolio?

Question 7. (2 points) What is the standard deviation of the return of your portfolio?

Problem 2. Second Portfolio (4 points)

We assume that CAPM holds. The Market Portfolio has a volatility of 10% and an
expected return of 8%. The risk free rate is 2%. Consider a portfolio consisting of the
following three stocks.

Portfolio Weight Volatility Correlation with the Market Portfolio

A 0.20 12.00% 0.4
B 0.25 18.00% 0.5
C 0.55 15.00% 0.3

Question 8. (1 point) What is the Beta of the portfolio?

Question 9. (1 point) What is the expected return of the portfolio?

Question 10. (2 points) Is 5.20% a volatility number possible for the portfolio?