Use the following information to answer the question(s)below.
Your investment portfolio consists of $10,000 worth of Google stock.Suppose that the risk-free rate is 4%,Google stock has an expected return of 14% and a volatility of 35%,and the market portfolio has an expected return of 12% and a volatility of 18%.Assume that the CAPM assumptions hold.
-The expected return on the alternative investment having the highest possible expected return while having the same volatility as Google is closest to?
A)21.6%
B)19.6%
C)23.4%
D)35.0%

Question

Quizplus · Accepted Answer

According to CAPM,
Expected Return of Google stock = Risk-free rate + Beta of Google (Expected Return of Market - Risk-free rate)
Beta of Google = volatility of Google / volatility of Market = 35% / 18% = 1.94

So, 
14% = 4% + 1.94 (12% - 4%)
14% = 4% + 1.94 (8%)
14% = 4% + 15.52%
Expected return of the market portfolio = 12%

Now, we need to find the alternative investment having the highest possible expected return while having the same volatility as Google. This means we need to find an investment that has a beta of 1.94 and a higher expected return than Google.

Let the expected return on the alternative investment be denoted by x. Then,
x = 4% + 1.94 (12% - 4%)
x = 4% + 15.52%
x = 19.52%

Therefore, the alternative investment having the highest possible expected return while having the same volatility as Google is the one with an expected return of 19.52%, which is closest to 19.6% (option B).

Use the Following Information to Answer the Question(s)below