Question

1.Stock A has a beta of 0.50 and Stock B has a beta of 1.25. Suppose rf is 4% and Rm is 10%.

a.Applying the security market line, determine the expected return for Stocks A and B.

b.What is the expected return of an equally weighted portfolio of these two stocks?

Answer 1

1)
a.	As per Capital asset Pricing model,
	Expected return for Stock A		=	rf	+	beta	*	(Rm-rf)
			=	4%	+	0.50	*	(10%-4%)
			=	7.00%
	Expected return for Stock B		=	rf	+	beta	*	Rm
			=	4%	+	1.25	*	(10%-4%)
			=	11.50%
b.	Expected return of portfolio			9.25%
Working:			Weight	Return
			a	b	a*b
	Stock A		0.5	7.00%	3.50%
	Stock B		0.5	11.50%	5.75%
	Total				9.25%