Answer:
a. The return predicted by CAPM for a portfolio with a beta of 1.4 is 11.88%
b. The alpha of portfolio A is -3.68%
Explanation:
The formula for computing the return by Capital Assets Pricing Method (CAPM) model.
Expected return = Risk Free rate + (Beta × Market Risk Premium)
where,
Market risk premium = market return - risk free rate
Now, putting the values in the above equation
a. Expected return = 0.06 + 1.4 × (0.102 - 0.06)
= 0.06 + 1.4 × 0.042
= 0.06 + 0.0588
= 0.1188
= 11.88 %
Thus, the return predicted by CAPM for a portfolio with a beta of 1.4 is 11.88%.
b. The alpha should be = Portfolio expected return - expected return
= 8.20 - 11.88 %
= -3.68%
Thus, the alpha of portfolio A is -3.68%
