Question

You own a portfolio that has 6,700 shares of stock A, which is priced at 18.1 dollars per share and has an expected return of 6.32 percent, and 1,800 shares of stock B, which is priced at 28.8 dollars per share and has an expected return of 16.35 percent. The risk-free return is 3.41 percent and inflation is expected to be 2.43 percent. What is the expected real return for your portfolio? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

Answer 1

Expected portfolio return = (weight of A*return of A)+(weight of B*return of B)

Investment in A = number of shares*price per share = 6,700*18.1 = 121,270

Investment in B = 1,800*28.8 = 51,840

Total investment = 121,270 + 51,840 = 173,110

Weight of A = investment in A/total investment = 121,270/173,110 = 0.7005

Weight of B = investment in B/total investment = 51,840/173,110 = 0.2995

Expected portfolio return = (0.7005*6.32%) + (0.2995*16.35%) = 9.32%

This is the nominal portfolio return.

1+nominal return = (1+ real return)*(1+inflation rate)

Expected real portfolio return = [(1+nominal return)/(1+inflation rate)] -1 = [(1+9.32%)/(1+2.43%)] -1 = 6.73% or 0.0673