$\begin{array}{|l|l|l|l|}
\hline \text { Factor } & {\left[\mathrm{E}\left(\mathrm{R}_{\mathrm{M}}\right)-\mathrm{R}_{\mathrm{F}}\right)} & \mathrm{SMB} & \mathrm{HML} \
\hline \text { Sensitivity } & \mathrm{b}_{\mathrm{i}}=1.75 & \mathrm{~s}_{\mathrm{i}}=-0.80 & \mathrm{~h}_{\mathrm{i}}=0.60 \
\hline \text { Risk premium } & 18.5 \% & 5.25 \% & 0.50 \% \
\hline
\end{array}$
-Suppose the above asset is observed in the market trading with an expected return of 18%.What strategy would you suggest to profit from this situation,assuming the CAPM was the correct pricing model and the risk-free rate was 8%?

A) buy the asset
B) short-sell the asset
C) buy the risk-free asset
D) sell the market portfolio

Question

$\begin{array}{|l|l|l|l|}
\hline \text { Factor } & {\left[\mathrm{E}\left(\mathrm{R}_{\mathrm{M}}\right)-\mathrm{R}_{\mathrm{F}}\right)} & \mathrm{SMB} & \mathrm{HML} \
\hline \text { Sensitivity } & \mathrm{b}_{\mathrm{i}}=1.75 & \mathrm{~s}_{\mathrm{i}}=-0.80 & \mathrm{~h}_{\mathrm{i}}=0.60 \
\hline \text { Risk premium } & 18.5 \% & 5.25 \% & 0.50 \% \
\hline
\end{array}$
-Suppose the above asset is observed in the market trading with an expected return of 18%.What strategy would you suggest to profit from this situation,assuming the CAPM was the correct pricing model and the risk-free rate was 8%?

A) buy the asset
B) short-sell the asset
C) buy the risk-free asset
D) sell the market portfolio

Quizplus · Accepted Answer

The CAPM (see the case study on page 277)can be expressed as E(R_i)= R_f + F1F1F1S1F1F1F10_i[(R_m)- R_f],and hence the expected return for the asset can be calculated as E(R)= 0.08 + 1.75(0.12)= 0.29 or 29.0%.If the asset was observed in the market to be trading with a return of 28%,then the market is out of equilibrium.The correct strategy would be to short-sell the asset,as it has a return lower than expected by the CAPM model.That is,the price of the asset is too high (i.e.the return is to low),and hence the investor can then profit from the expected future fall in price as the market moves back into equilibrium.

-Suppose the Above Asset Is Observed in the Market Trading