Question

3. If the risk-free rate is 6% and the expected return of the market is 12%, what is the expected return of a portfolio that is equally invested in

treasury bills and a stock with a beta of 1.3?

A. 9.9% B. 10.2% C. 13.8% D. 12.9% E. 19.8%

The answer is A. Please show the precess.

Answer 1

First, we find the expected rate of return of portfolio using CAPM:

Expected return = risk free rate + beta ( expected return on market - riskk free rate)

Expected return = 0.06 + 1.3 ( 0.12 - 0.06)

Expected return = 0.06 + 1.3 ( 0.06)

Expected return = 0.06 + 0.078

Expected return = 0.138 or 13.8%

Since the money is equally invested, weight of both portfolio and risk free asset will be 0.5.

Expected return = 0.5 * 0.138 + 0.5 * 0.06

Expected return = 0.069 + 0.03

Expected return = 0.099 or 9.9%