# calculating expected return (triple jeopardy??)

saw a question today, and it’s got me all panicky. one huge problem i’m having on level 3 is trying to forget what you might have learned earlier in school Rf = 6% you forecast stock market up 12% your stock portfolio has beta of 1.4 what do you forecast that your stock portfolio will be up? i’m sure you see where i’m going with this, but it makes a difference. and this was a triple jeopardy, arguably quadruple jeopardy question (somewhat mitigated by the fact the Rf was quite low, so it didn’t make a huge difference)… i changed the exact numbers and the info was not presented in 3 simple lines like the above. i apologize in advance as i’m heading out for a few hours. i should also go back and see how many jeopardies it actually was (but i’d argue it gets you really flustered and anxious about subsequent answers)

14.4%? For the record, I’m predicting the CFAi drops a quintuple jeopardy on us to start the morning off right.

I don’t know exactly how they expressed that you forcast the stock market up 12% based on that there would be 2 answers for me 1. you expect the market to have a 12% yearly return - your portfolio should go up 14.4% 2. you think that the stock market will go up 12% short term - the portfolio should go up 16.8%

14.4% but based on the panic I would say that must be wrong.

florinpop Wrote: ------------------------------------------------------- > I don’t know exactly how they expressed that you > forcast the stock market up 12% > > based on that there would be 2 answers for me > 1. you expect the market to have a 12% yearly > return - your portfolio should go up 14.4% > 2. you think that the stock market will go up 12% > short term - the portfolio should go up 16.8% how do u get the 16.8% for the short term??

is this a frame dependence experiment?

heer Wrote: ------------------------------------------------------- > how do u get the 16.8% for the short term?? He is just doing 12%*1.4 I think. But I would have answered 14.4%…

well I just thought that beta represents systematic risk, and for a change in market you expect more volatility in this case. so for short term I thought it can be an aproximation 14.4% would be correct if the estimated market return is for a year, then assuming efficient markets you can use the formula. that is why I said it depends on how it was stated in the q.

basically they did 1.4 times 12% so 16.8%… ala the market model in level 2 (i think), although i’ve never really seen this anywhere other than level 2 but the way you do it with CAPM i think is the following: Rf + Beta * (Rm - Rf). so 6% plus 1.4 * (12% - 6%)… or, 14.4%… i think either way is somewhat ok… second way is better, i think… but it just seems like they mix and match so much stuff and then do things differently than university or even other levels of CFA curriculum (or different than other areas of level 3). it’s just not good to look at this stuff and stress over what they assume when you know how to do it either way. one thing i will say is that schweser stuff caused confusion last year and the real exam was pretty clear in its wording.

westbruin did they say the expected market return for a YEAR is 12%? if not you can’t really use rf+beta*(RM-RF) I think

florinpop Wrote: ------------------------------------------------------- > westbruin did they say the expected market return > for a YEAR is 12%? > > if not you can’t really use rf+beta*(RM-RF) > I think that’s most likely how they see it… but i’m pretty sure that’s how people calculate beta. almost all services that i know… but yes, i’m pretty sure that’s the most reasonable explanation and of course i was thinking of both ways as i was doing question (before i saw the answer)

I think we are confusing (2) things: Since I am not so throughtful I immediately assumed the stock expected movement would be up 16.8% - simply the forecast market move times the Beta (we see this application in the implementation shortfall curriculum when we try to remove the market explained portion of the shortfall from the total realized shortfall). The 14.4% measure is actually the determination of the required return on the stock! But the most direct measure of the market movement me thinks is simply the market move times the stocks Beta.