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Risk, return, and the capital asset pricing model

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Andrea Corbridge is considering forming a portfolio consisting of Kalama Corp. and Adelphia Technologies. The corporations have a correlation of -0.1789, and their expected returns and standard deviations are as follows:

Kalama Corp. Adelphia Technologies
Expected returns (%) 14.86 23.11
Standard Deviation (%) 23.36 31.89

1. Calculate the frontier for all possible investment combinations of Kalama Corp. and Adelphia Technologies (from 0% to 100%, in 1% increments). Determine the optimal risky portfolio if the risk-free rate is 3%.

2. Andrea has $50,000 and wants to earn a 19% expected return on her investment. What is the optimal manner in which to structure her portfolio-both in dollar amounts and in weights relative to her $50,000-based on the preceding information?

3. Andrea is also seriously considering buying some stock in Medford Barnett Corporation (MBC). The stock prices of MBC and the S&P for the past 25 months are tabulated below. Andrea estimates that MBC will earn a 14% return during the next year, and she expects the market to earn a 12% return during the same period. In addition, she expects the relationship exhibited between the S&P and MBC to remain as it has in the past. Assuming that Andrea would be pulling MBC into a fully diversified portfolio, is buying the MBC shares a good decision?

Month S&P MBC
1 1,198.41 58.04
2 1,228.81 65.36
3 1220.33 48.48
4 1234.18 53.32
5 1191.33 57.59
6 1191.50 49.23
7 1156.85 55.57
8 1180.59 50.99
9 1203.60 64.10
10 1181.27 50.45
11 1211.92 50.65
12 1173.82 51.23
13 1130.20 46.68
14 1114.58 51.09
15 1104.24 50.75
16 1101.72 59.80
17 1140.84 52.78
18 1120.68 49.22
19 1107.30 53.47
20 1126.21 49.26
21 1144.94 48.55
22 1131.13 61.32
23 1111.92 48.06
24 1058.20 58.88
25 1050.71 46.19

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Solution Summary

Risk, returns and the capital asset pricing models is examined.

Solution provided by:
Jayant Kumar, MBA
Education
  • MBA, Indian Institute of Finance
  • Bsc, Madras University
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