Securities A,B,C have the following;
Sec. Exp.Ret. Beta
A 10 .7
B 14 1.2
C 20 1.8
According to CAPM, what is the correct slope between security A&B?
A&C?
To find the correct slope between the securities A and B, we can use the formula provided by the Capital Asset Pricing Model (CAPM). CAPM states that the expected return of a security is equal to the risk-free rate plus the product of the security's beta coefficient and the market risk premium.
The formula for CAPM is:
Expected Return = Risk-Free Rate + (Beta * Market Risk Premium)
Given the data provided, we have:
Security A:
Expected Return (A) = 10%
Beta (A) = 0.7
Security B:
Expected Return (B) = 14%
Beta (B) = 1.2
To calculate the slope between securities A and B, we need to subtract the risk-free rate from the expected returns of each security, and divide the result by the difference in their betas.
Slope (A & B) = (Expected Return (A) - Risk-Free Rate) / (Beta (A) - Beta (B))
Using the given data:
Risk-Free Rate = Let's assume it to be 5%
(You can look up the current risk-free rate from government bond rates or financial news websites)
Slope (A & B) = (10% - 5%) / (0.7 - 1.2) = 5% / (-0.5) = -10%
Therefore, the correct slope between securities A and B is -10%.
To calculate the slope between securities A and C, we can use the same formula. Let's substitute the respective values:
Security C:
Expected Return (C) = 20%
Beta (C) = 1.8
Slope (A & C) = (Expected Return (A) - Risk-Free Rate) / (Beta (A) - Beta (C))
Using the given data:
Slope (A & C) = (10% - 5%) / (0.7 - 1.8) = 5% / (-1.1) = -4.55%
Therefore, the correct slope between securities A and C is -4.55%.