Question

What is the required return of the following well-diversified portfolio if the risk-free rate is 2% and the return on the market is 9%?

Stock	Amount	Beta	Expected Return
A	$100,000	1.2	10
B	$200,000	0.8	8
C	$100,000	1.4	12

Answer 1

The required return is computed as shown below:

= risk free rate + beta x ( return on market - risk free rate)

beta is computed as shown below:

= Beta of stock A x weight of stock A +  Beta of stock B x weight of stock B +  Beta of stock C x weight of stock C

= 1.2 x $ 100,000 / $ 400,000 + 0.8 x $ 200,000 / $ 400,000 + 1.4 x $ 100,000 / $ 400,000

= 1.05

So, the return will be computed as follows:

= 0.02 + 1.05 (0.09 - 0.02)

= 9.35%

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