Question

A). A stock has a beta of 1.02, the expected return on the market is 0.09, and the risk-free rate is 0.05. What must the expected return on this stock be? Enter the answer with 4 decimals (e.g. 0.1234).

B).

You own a portfolio that has $4100 invested in Stock A and $4900 invested in Stock B. If the expected returns on these stocks are 0.18 and 0.01, respectively, what is the expected return on the portfolio?

Enter the answer with 4 decimals (e.g. 0.1234).

Answer 1

A

By CAPM, Expected Return on Stock = Risk free rate + Beta * (Expected Market Return - Risk Free Rate)

=> Expected Return on Stock = 0.05 + 1.02 * (0.09 - 0.05) = 0.05 + 0.0408 = 9.0800%

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B

Expected Return on Portfolio = Weight of Stock A * Return of Stock A + Weight of Stock B * Return of Stock B

Weight of Stock A = 4100/(4100 + 4900) = 45.56%

Weight of Stock B = 4900/(4100 + 4900) = 54.44%

Expected Return on Portfolio = (45.56% * 0.18) + (54.44% * 0.01) = 8.7452%