Marion and Birkan (i.e.M and B)are aspiring young investment students.During the lecture on asset pricing,both were inspired by the beauty of the models presented.M found the CAPM model overly simplistic and favoured the Fama-French model,while B disagreed,and instead believed that the CAPM,being more theoretical,was the better model.As part of a class assignment,they were each given the tabled information regarding an asset and asked to recommend a trading strategy based upon their preferred asset pricing model.If the asset is observed in the market trading with an expected return of 28%,and the risk-free rate is 8%,what are the relative trading strategy recommendations of each investor?

A) Both M and B will recommend buying the asset
B) Both $ \mathrm{M} $ and B will recommend short-selling the asset
C) M will recommend buying the asset, while B will recommend short-selling the asset
D) B will recommend buying the asset, while M will recommend short-selling the asset

Question

Marion and Birkan (i.e.M and B)are aspiring young investment students.During the lecture on asset pricing,both were inspired by the beauty of the models presented.M found the CAPM model overly simplistic and favoured the Fama-French model,while B disagreed,and instead believed that the CAPM,being more theoretical,was the better model.As part of a class assignment,they were each given the tabled information regarding an asset and asked to recommend a trading strategy based upon their preferred asset pricing model.If the asset is observed in the market trading with an expected return of 28%,and the risk-free rate is 8%,what are the relative trading strategy recommendations of each investor?

A) Both M and B will recommend buying the asset
B) Both $ \mathrm{M} $ and B will recommend short-selling the asset
C) M will recommend buying the asset, while B will recommend short-selling the asset
D) B will recommend buying the asset, while M will recommend short-selling the asset

Quizplus · Accepted Answer

Birkan (B)favours the CAPM: The CAPM (see the case study CCAPM Estimate for BHP Billiton)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 were observed in the market to be trading with a return of 28%,then the market is out of equilibrium.Therefore,B's recommendation,based on the CAPM,is that the asset's return is too low,and hence the asset should be short-sold.

Marion and Birkan (I M \mathrm{M} M And B Will Recommend Short-Selling the Asset C) M Will

Marion and Birkan (I $\mathrm{M}$ And B Will Recommend Short-Selling the Asset
C) M Will