Question

You own a portfolio that has a total value of 131,000 dollars. The portfolio has 5,000 shares of stock A, which is priced at 8 dollars per share and has an expected return of 11.98 percent. The portfolio also has 20,000 shares of stock B, which has an expected return of 16.75 percent. The risk-free return is 5.26 percent and inflation is expected to be 2.42 percent. What is the risk premium for your portfolio? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

Answer 1

Portfolio value = Value of stock A + Value of Stock B

=5000*8+ 20000* (share price of Stock B)

= $ 131000

Thus share price of Stock B = $ 4.55

Weight of stock A in portfolio = Value of stock A/Value of portfolio

= 40000/131000 = 0.305

Similarly,

Weight of stock B in portfolio = Value of stock B /Value of portfolio

= (4.55 * 20000)/131000

= 0.695

Expected return of portfolio = (A's Weight)*(Expected return of A) + (B's Weight)*(Expected return of B)

= (0.305) * ( 11.98%) + (0.695)* (16.75%)

=0.036539 + 0.1164125

=0.15295 = 15.29%

Risk premium of portfolio = Expected return of portfolio - risk-free return

= 0.15295- 5.26%

= 0.15295-0.0526 = 0.10035 = 10.035%