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Answer: The expected portfolio return increases by 0.896%
## Explanation Using the CAPM formula: Expected Return = Risk-Free Rate + Beta × (Market Return - Risk-Free Rate) **Initial calculation with 8.2% market return:** Expected Return = 2.4% + 1.12 × (8.2% - 2.4%) = 2.4% + 1.12 × 5.8% = 2.4% + 6.496% = 8.896% **Revised calculation with 9.0% market return:** Expected Return = 2.4% + 1.12 × (9.0% - 2.4%) = 2.4% + 1.12 × 6.6% = 2.4% + 7.392% = 9.792% **Impact of adjustment:** 9.792% - 8.896% = 0.896% Alternatively, we can calculate the impact directly: Change in expected return = Beta × Change in market return premium Change in market return premium = (9.0% - 2.4%) - (8.2% - 2.4%) = 6.6% - 5.8% = 0.8% Impact = 1.12 × 0.8% = 0.896% Therefore, the expected portfolio return increases by 0.896%, which corresponds to option A.
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Roman, FRM, is adopting a CAPM framework in his investment strategy. The current prevailing 3-month T-bill rate is 2.4% and Roman's portfolio has a beta of 1.12. Suppose that based on new information, Roman adjusts his forecast on S&P 500's return from 8.2% to 9.0% in the model. What is the impact of this adjustment on the expected portfolio return based on the CAPM equation?
A
The expected portfolio return increases by 0.896%
B
The expected portfolio return increases by 0.800%
C
The expected portfolio return increases by 0.560%
D
The expected portfolio return increases by 0.224%