You observe that IBM, Google, and Facebook’s stock returns have the betas in the table provided below. Suppose the expected market return is 8% and the risk-free rate is 3%.
Stock Beta:
IBM 1.5
GOOGLE 0.9
FB 0.5
a. Suppose the CAPM holds, what is the expected excess return for each stock?
b. You decide to take a long position in IBM and a short position in Google. According to the CAPM, what is the expected return from this investment strategy?
c. You regressed your portfolio that takes a long position in IBM and a short position in Google, on excess market returns. The equation you estimated is below. ( ) According to the CAPM what is the expected value of each parameter and why?
a+B(Rm-Rf)+e
(i.e. E(a) = ?, E(B) = ?, E(e)=?)