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    Risk and Return Problems

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    Please help with the following problems.

    Risk and Return. True or false? Explain or qualify as necessary.
    a. The expected rate of return on an investment with a beta of 2 is twice as high as the expected
    rate of return of the market portfolio.
    b. The contribution of a stock to the risk of a diversified portfolio depends on the market risk
    of the stock.
    c. If a stock's expected rate of return plots below the security market line, it is underpriced.
    d. A diversified portfolio with a beta of 2 is twice as volatile as the market portfolio.
    e. An undiversified portfolio with a beta of 2 is twice as volatile as the market portfolio.

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    Solution Preview

    a) False. Consider the CAPM formulae Expected Return = Risk Free Rate + Beta * Market Premium. If you use a beta of 2, no doubt you get twice the market premium, but what about the risk free rate? In the mid 1990's the risk free rate was as high as 9%, so you will not get double the ...

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    This solution helps with true and false problems involving risk and return.

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