The Expected Return for the Market Is 12 Percent,with a Standard

question 48

Essay

The expected return for the market is 12 percent,with a standard deviation of 20 percent.The expected risk-free rate is 8 percent.Information is available for three mutual funds,all assumed to be efficient,as follows:
$$\begin{array} { l c } \text { Mutual Funds } & \operatorname { SD } ( \% ) \\\hline \text { Affiliated } & 15 \\\text { Omega } & 17 \\\text { Ivy } & 19\end{array}$$ (a)Based on the CML,calculate the market price of risk.
(b)Calculate the expected return on each of these portfolios.

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Definitions:

Pre-Tax Cost

The pre-tax cost of debt is the interest rate a company pays on its borrowings before taking into account the tax deductions that reduce the effective interest cost.

Debt-Equity Ratio

A benchmark ratio illustrating how a company’s assets are financed by shareholders' equity and debt.

M&M II

Modigliani and Miller Proposition II; a theory on capital structure, which states that the value of a firm is independent of its capital structure, under certain assumptions.

Unlevered Cost

It refers to an investment's cost or return that does not consider the effects of borrowing or leverage.