Mock PM #57

For #57

Using the CAPM calculation, none of the three stocks have the correct expected return. Why do we choose FUJI over the others??

I can’t recall, but it was above the SML for it’s given beta.

If I recall, Fuji was below the line, meaning it was overpriced (so we wouldn’t want Fuji, contrary to his recommendation). The other two choices were underpriced per the CAPM.

If I remember correctly isn’t it due to having the highest Sharpe or information ratio?

highest sharpe ratio

No, they say [exhibit 2 is consistent with CAPM]. The question asks which security’s risk-return profile is least likely consistent with this observation.

If you calculate the CAPM return for FUJI, it is higher than the expected return given. Therefore, FUJI must be overpriced according to the CAPM framework. You wouldn’t want to long an overpriced asset.

FUJI, given its risk-return profile, is least consistent with the CAPM.

Edit: fixed it–nothing to do with pharma…but, also nothing to do with the sharpe ratio. Also, the more I read this, the more I think it’s a low quality question and answer.

Yes, this one got me as well. It’s really badly written and unclear.

In the question, it states ‘… the resulting valuations seem to be the basis of your decision to overweight the Pharma sector.’

So that would imply that they overweight Pharma as Pharma stocks are attractively valued. So if a Pharma stock is undervalued or a non-Pharma stock is overvalued, this is consistent with the observation. FUJI is a non-Pharma stock and overvalued, so that shoud be consistent with this, but that is given as the answer.

Very annoying one that. Good to see others got it too, shows that you have a good understanding of the question at least!

They tell you to refer to the CAPM part of obs.#2, not the pharma. So, with CAPM, we would expect a higher return for a higher beta, but FUJI doesn’t comply with this in the presence of the other two. The other idea I thought of is that since it was overvalued via the CAPM, we wouldn’t want to purchase it (less solid of an approach, if you ask me).

where do they get the 14% market return from

One of the last stocks in the list has a beta of 1 and a return of 14%-- that’s what I did, and it matched their “market return”.

The last stock is the all-world index. Decent benchmark for market return

Ah, the details I missed! I just figured a beta of 1 was good to go- didn’t realize it was the world index! Good catch.

Not necessarily a missed detail though, a beta of 1 implies the market portfolio. You just had to read less words, saved yourself one valuable second :slight_smile:

I see your point that I was able to get the market return (or equivalent) by this approach, but be careful with that statement. A beta of 1 doesn’t imply the market portfolio; it implies the asset has the same level of systematic risk as the market. Ah, the details devil (unless I’m missing something).