Question

A. You own a $20,000 portfolio that is invested in a risk-free security and Stock A....

A. You own a $20,000 portfolio that is invested in a risk-free security and Stock A. The beta of Stock A is 1.60 and the portfolio beta is 1.00. What is the amount of the investment in Stock A?

B. Stock A has a beta of 2.0 and an expected return of 13.0 percent. Stock B has a beta of 1.12 and an expected return of 13.70 percent. At what risk-free rate would these two stocks be correctly priced?

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Answer #1

A.

Beta of risk free security = 0

Portfolio beta = Stock A beta x Weight of Stock A + Risk free rate beta x Weight of risk free security

1 = 1.6 x Weight of A + 0 x Weight of risk free security

Weight of A = 1/1.6 = 62.5%

Total investment in A = Portfolio Value x Weight of A

Total investment in A = 20000 x 62.5% = $12,500

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I tried to solve B part of the problem but getting very high risk free rate...which is not convincing to me. I am getting Risk free rate as 14.59%

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