Which of the following equations is INCORRECT? A) Required Returnnominal = [(1 + Risk Free Ratereal)*(1 + Expected Inflation)*(1 + Risk Premium)] - 1. B) Beta = (Covi, mkt) / (ó2mkt). C) Standard Deviation2-Stock Portfolio = [(w12 * ó12) + (w22 * ó22) + (2 * w1 * w2 ó1ó2 * ñ1,2)]. D) Real Risk-Free Rate = [(1 + nominal risk-free rate) / (1 + expected inflation)] - 1. Your answer: C was correct! ------------------------------------------------------------------------------------------------------- one of the assumptions of the capital market theory is there is no inflation or inflation is fully anticipated, so there is no change to interest rates, now choice a in this question incorporates inflation, but it’s somehow missing beta, anyone know the derivation for this equation?
OMG, it takes a lot of effort to consistently come up with questions like this, you pop up a lot on here.
thanks to schweser, what else can I say… so anyone with any thoughts on how they derive that equestion for required returns without beta but with inflation factored in?
That formula is present in the text (Schweser, Stalla & CFA somewhere) Nominal Rate = Risk Free Rate + E(Infl) + Risk Premium (Chapter 1 of Quant). This above is an approximation Going by Math & First principles 1+Nominal Rate = (1 + RRF) ( 1 + E(Infl) ) (1+Risk Premium) Hence the Nominal rate derivation. This is present in the Equity chapter I believe.
Same thing works for D as well.