Question

CAPM AND PORTFOLIO RETURN

You have been managing a $5 million portfolio that has a beta of 2.00 and a required rate of return of 10%. The current risk-free rate is 3.50%. Assume that you receive another $500,000. If you invest the money in a stock with a beta of 1.90, what will be the required return on your $5.5 million portfolio? Do not round intermediate calculations. Round your answer to two decimal places.

%

Answer 1

As per CAPM

expected return = risk-free rate + beta * (expected return on the market - risk-free rate)

10 = 3.5 + 2 * (Market return% - 3.5)

Market return% = 6.75

new beta = old beta*weight of portfolio invested in old asset+new asset beta*weight of portfolio invested in new asset

= 2*5000000/(5500000)+1.9*500000/(5500000)

=1.9909

As per CAPM

expected return = risk-free rate + beta * (expected return on the market - risk-free rate)

Expected return% = 3.5 + 1.9909 * (6.75 - 3.5)

Expected return% = 9.97