Question

You own a portfolio that has 5,900 shares of stock A, which is priced at 15.2 dollars per share and has an expected return of 5.27 percent, and 1,000 shares of stock B, which is priced at 22.1 dollars per share and has an expected return of 14.19 percent. The risk-free return is 3.79 percent and inflation is expected to be 2.05 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

The real rate is computed as shown below:

= [ (1 + Nominal rate) / (1 + inflation rate) ] - 1

Nominal rate is computed as follows:

= return of stock A x weight of stock A + return of stock B x weight of Stock B

= 0.0527 x (5,900 x $ 15.2) / [ (5,900 x $ 15.2 + 1,000 x $ 22.1) ] + 0.1419 x (1,000 x $ 22.1) / [ (5,900 x $ 15.2 + 1,000 x $ 22.1) ]

= 0.0527 x $ 89,680 / $ 111,780 + 0.1419 x $ 22,100 / $ 111,780

= 0.070335713

So, the real rate will be as follows:

= [ (1 + 0.070335713) / (1 + 0.0205) ] - 1

= 0.0488 Approximately

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