Question

The expected return on Stock A is 12% and its variance is 0.15. The current money market fund has a sure rate of 3%. If you borrow $5,000 of the money market fund from a friend and use the money along with $10,000 of your own money to purchase A, what is the expected return on your portfolio?

A. 16.5%

B. 10.8%

C. 9.0%

D. 19.5%

Answer 1

Given that,

Expected return on stock A, Ra = 12%

current money market fund rate Rf = 3%

amount borrowed = $5000

Own fund = $10000

So, investment in stock A = 10000 + 5000 = $15000

So, weight in money market fund Wf = -Money market fund/own fund = -5000/10000 = -50%

Weight in stock A, wa = investment in stock A/own fund = 15000/10000 = 150%

So, expected return on portfolio is weighted average return on its assets,

=> Expected return on portfolio = Wa*Ra + Wf*Rf = 1.5*12 - 0.5*3 = 16.50%

Option A is correct.