Faculty of Economics and Business
Department of Business
FINANCE I (102329) – Group 3 – 2012-13
Study Guide. Dr. Maria-Antonia Tarrazon & Dr. Joan Montllor
1
EXERCISE 5: THE TRIBE OF THE REVELRY-AND-SPREE1
Exercise to check your knowledge about the CML and the SML. SOLUTION
ANSWER SHEET. EXERCISE 5: THE TRIBE OF THE REVELRY-AND-SPREE
1. Capital Market Line: equation and drawing (including the parameters of this case)
pp σ
0.098478
0.050.2643
0.05)E(R
= 0.05 + 2.1761p
Drawing: include the parameters of this case (in other words, there are only two stocks, not a set of
stocks that produces a feasible set of risky assets looking like an “umbrella”).
Security Market Line: equation and drawing (including the parameters of this case)
Rrequired j = E(Rj) = 0.05+ (0.2643 – 0.05)·j = 0.05 + 0.2143·j
Drawing: include the parameters of this case.
2. Meaning of coefficient beta:
Sensitivity measure between return on stock j and return on market index M.
Formula:
2
M
jMMj
2
M
jM
2
M
Mj
jσ
·ρ·σσ
σ
σ
σ
)R,Rcov(
β
~~
If j<1 j is a defensive security, while if j>1 j is an aggressive security. M=1 always.
See extended definition (concept, drawings and formula) in textbooks and/or class notes.
Coefficient beta of GranCacao (calculated both using covariances and the SML):
Using covariances: (notice that we do not know GC,M, therefore we have to use an indirect way to
calculate the covariance GC,M, a way in which we can use GC,CK=0,10 which we know):
161.1
0.098478
0.011314
0.098478
20·0.12·0.10.2381·0.120.7619·0.1
σ
0.2381·σ0.7619·
σ
)R
~
0.2381·R
~
0.7619·,R
~
cov(
σ
)R
~
,R
~
cov(
β
22
2
2
M
CKGC,
2
GC
2
M
CKGCGC
2
M
MGC
GC
Notice: This means that 0.011314 is the covariance GC,M. From it we can calculate GC,M:
0.011314 = 0.12·0.098478·GC,M GC,M= 0.95741 GC is highly correlated with M.
SML: 0.30 = 0.05 + 0.2143·GC GC =
61.1
> 1 Gran Cacao aggressive security
Coefficient beta of Cocos-Kiko (calculated both using covariances and the SML):
Using covariances: (notice also that we do not know CK,M, therefore we have to use an indirect way
to calculate the covariance CK,M, a way in which we can use GC,CK=0.10 that we know):
1 In Catalan known as “la Tribu dels Vinga-Sarau”.
