Question

Consider a $10 million portfolio that consists of the following five stocks:

Stock | $Amount Invested | Beta |

A | 4 million | 1.7 |

B | 2 million | 1.1 |

C | 2 million | 1.0 |

D | 1 million | 0.7 |

E | 1 million | 0.5 |

What is the required return on this portfolio if the risk free rate of return is 5.9% and the market risk premium is 5%?

Answer #1

Total Portfolio value = Value of A + Value of B + Value of C + Value of D + Value of E |

=4+2+2+1+1 |

=10 |

Weight of A = Value of A/Total Portfolio Value |

= 4/10 |

=0.4 |

Weight of B = Value of B/Total Portfolio Value |

= 2/10 |

=0.2 |

Weight of C = Value of C/Total Portfolio Value |

= 2/10 |

=0.2 |

Weight of D = Value of D/Total Portfolio Value |

= 1/10 |

=0.1 |

Weight of E = Value of E/Total Portfolio Value |

= 1/10 |

=0.1 |

Beta of Portfolio = Weight of A*Beta of A+Weight of B*Beta of B+Weight of C*Beta of C+Weight of D*Beta of D+Weight of E*Beta of E |

Beta of Portfolio = 1.7*0.4+1.1*0.2+1*0.2+0.7*0.1+0.5*0.1 |

Beta of Portfolio = 1.22 |

As per CAPM |

expected return = risk-free rate + beta * (Market risk premium) |

Expected return% = 5.9 + 1.22 * (5) |

Expected return% = 12 |

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