Question

Consider the capital asset pricing model. The market degree of risk aversion, A, is 3 . The variance of returns on the market portfolio is .0225 . If the risk-free rate of return is 5%, the expected return on the market portfolio is ___.

a) 11.75%
b) 9.84%
c) 8.67%
d) 10.75%

Answer 1

The expected return on the market portfolio, given a market degree of risk aversion of 3, a variance of returns on the market portfolio of 0.0225, and a risk-free rate of return of 5%, is calculated as 11.75%.

Step-by-step explanation:

When considering the Capital Asset Pricing Model (CAPM), which calculates the expected return on an asset given the risk-free rate of return, market risk premium, and the asset's beta, we can calculate the expected return on the market portfolio. Given that the market degree of risk aversion (A) is 3, the variance of returns on the market portfolio is 0.0225, and a risk-free rate of return is 5%, the expected return on the market portfolio (E[Rm]) can be found using the formula E[Rm] = Rf + A * σ^2, where Rf is the risk-free rate and σ^2 is the variance of the market portfolio. Substituting the given values, E[Rm] = 5% + 3 * 0.0225, simplifying to E[Rm] = 5% + 0.0675 or E[Rm] = 11.75%.