Question

What is the CAPM required return of a portfolio with 40% invested in the market portfolio, 18% invested in risk-free assets, and the rest invested in a stock with a beta of 2.3? The risk free rate is 0.8% and the expected market risk premium is 5.8%. Answer in percent, rounded to two decimal places.

Answer 1

Given for a portfolio,

40% invested in the market portfolio, 18% invested in risk-free assets, and the rest invested in a stock with a beta of 2.3

Beta of market portfolio = 1

Beta of risk free assets = 0

We know that, beta of a portfolio is weighted average beta of its assets.

So beta of this portfolio is

Beta = weight in market portfolio*Beta of market portfolio + weight in risk free asset*Beta of risk free assets + weight in stock*Beta of stock = 0.4*1 + 0.18*0 + 0.42*2.3 = 1.366

So, beta of the portfolio = 1.366

Given that, risk free rate Rf = 0.8%

expected market risk premium MRP = 5.8%

So, using CAPM, expected return on the portfolio = Rf + beta*MRP = 0.8 + 1.366*5.8 = 8.72%