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    Capital Asset Pricing Model- expected return, volatility

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    2. Your investment portfolio consists of $15, 000 invested in only one stock-Microsoft. Suppose the risk free rate is 5%, Microsoft stock has an expected return of 12% and a volatility of 40%, and the market portfolio has an expected return of 10% and a volatility of 18%.
    Under the CAPM assumptions,
    a. What alternative investment has the lowest possible volatility while having the same expected return as Microsoft?
    b. What investment has the highest possible expected return while having the same volatility as Microsoft?

    6. Suppose the risk free return is 4% and the market portfolio has an expected return of 10% and a volatility of 16%. Johnson and Johnson Corporation (ticker JNJ) stock has a 20% volatility and a correlation with the market of 0.06.
    a. What is Johnson and Johnson's beta with respect to the market?
    b. Under the CAPM assumptions, what is its expected return?

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    Solution Preview

    Please see the attached file:
    2.  Your investment portfolio consists of $15, 000 invested in only one stock-Microsoft.  Suppose the risk free rate is 5%, Microsoft stock has an expected return of 12% and a volatility of 40%, and the market portfolio has an expected return of 10% and a volatility of 18%.  
    Under the CAPM assumptions,
    a. What alternative investment has the lowest possible volatility while having the same expected return as Microsoft?

    We will use a portfolio on Capital Market Line (CML):

    Capital Market Line (CML) equation is:
    r p= r f + σp (r m - r f)/σm or σp = (rm-rf) x σm / (rm-rf)

    risk free rate= r f = 5.00%
    return on market portfolio= r m = 10.00%
    volatility of efficient portfolio= σp= to be determined
    volatility of market portfolio= σm= 18.00%
    return on efficient portfolio= r p = 12.00%
    Plugging in the values
    σp= 25.20% =(12.%-5.%)x18.%/(10.%-5.%)

    The alternative investment has a return of 12.00% and volatility of ...

    Solution Summary

    Calculates volatility, expected return, beta using CAPM assumptions.

    $2.19

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