Question

1. What are the expected return and the standard deviation for the CoR Stock?

                                                            CoR Stock

Scenario	Probability of Scenario	Rate of Return
Worst Case	0.10	−11%
Poor Case	0.20	−4%
Most Likely	0.40	−2%
Good Case	0.20	8%
Best Case	0.10	14%

4. Your client decides to invest $1.4 million in Flama stock and $0.6 million in Blanca stock. The risk-free rate is 4% and the market risk premium is 5%. The beta of the Flama Stock is 1.2; and the beta of the Blanca stock is 0.8.
   1. What are the weights for this portfolio?
   2. What is the portfolio beta?
   3. What is the required return of the portfolio?

Answer 1

1)

Expected return = Summation of [Probability*Rate of return]

Expected return = 0.10*(-11%) + 0.20*(-4%) + 0.40*(-2%) + 0.20*(8%) + 0.10*(14%)

Expected return = 0.3%

Standard deviation = Summation of [Probability*(Return-Expected return)^2]

Standard deviation = 0.10*(-11%-0.3%)^2 + 0.20*(-4%-0.3%)^2 + 0.40*(-2%-0.3%)^2 + 0.20*(8%-0.3%)^2 + 0.10*(14%-0.3%)^2

Standard deviation = 0.492%

2)

Weight of Flama stock this portfolio = 1.4/(1.4+0.6) = 70%

Weight of Blanca stock this portfolio = 0.6/(1.4+0.6) = 30%

Portfolio beta = Summation of [Weight*Stock Beta]

Portfolio beta = 0.7*1.2+0.3*0.8 = 1.08

Required return on the portfolio = Risk free rate + Beta*(Market risk premum)

Required return on the portfolio = 0.04+1.08*(0.05-0.04)

Required return on the portfolio = 5.08%