TRADING CASE RP1
Risk, expected return, and CAPM price discovery
LEARNING OBJECTIVE
Connect spot prices to expected returns, diversification, mean-variance efficiency, and CAPM.
KEY CONCEPTS
Capital market line | Security market line | Diversification | Price discovery
HOW THE CASE WORKS
Stocks in Companies A, B, and C trade for one period. At the end of trading, one of nine equally likely economic paths is realized and each position is liquidated at that path's value.
CASE DATA
| Path | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | Avg. |
|---|---|---|---|---|---|---|---|---|---|---|
| Company A | 39.112 | 34.786 | 30.459 | 28.295 | 23.969 | 22.238 | 19.642 | 17.478 | 13.157 | 24.459 |
| Company B | 43.218 | 40.762 | 38.306 | 37.078 | 34.623 | 33.640 | 32.167 | 30.939 | 28.483 | 35.469 |
| Company C | 39.889 | 44.777 | 49.665 | 52.109 | 56.997 | 58.953 | 61.886 | 64.330 | 69.218 | 53.314 |
| Market index | 1400 | 1300 | 1200 | 1150 | 1050 | 1010 | 950 | 900 | 800 | 1084.444 |
MARKET SETTING
Cash earns or costs 1% for the period. Borrowing and short selling are allowed. The market index is provided as a benchmark but cannot be traded. Each trial begins with a fresh portfolio worth slightly more than $1 million in expected value.
TRADING RULES
- Students discover each stock's spot price by submitting bids and asks.
- Expected return depends on the price discovered in the market.
- Use the nine paths to compare expected return, volatility, and covariance with the index.
- Manage both total portfolio risk and expected return across independent trials.
AFTER TRADING CLOSES
The realized event or economic path determines the security payoffs. Cash, long positions, and short positions are settled according to the case rules.
PERFORMANCE: Grade cash = 1000 x ln(closing market cash). The logarithm rewards higher final wealth while making each additional gain progressively less valuable, encouraging you to consider both risk and return. If market cash is zero or negative, grade cash is zero; results accumulate across trials.