Question

14. Stock A has a beta of 1.95 and a standard deviation of return of 42%. Stock B has a beta of 3.75 and a standard deviation of return of 70%. Assume that you form a portfolio that is 60% invested in Stock A and 40% invested in Stock B. Using the information in question 13, according to CAPM, what is the expected rate of return on your portfolio? Enter your answer rounded to two decimal places.

Question 13 for reference

The expected rate of return on the market portfolio is 13.25% and the risk–free rate of return is 3.00%. The standard deviation of the market portfolio is 18.75%. What is the representative investor’s average degree of risk aversion? Note that the degree of risk aversion is shown as a number rather than a percentage. Enter your answer rounded to two decimal places.

Answer 1

14. rm = 13.25%

rf = 3%

Stock A beta = 1.95

The required return on Stock A using CAPM:

re = 0.229875

The required return on Stock B using CAPM:

Stock B beta = 3.75

re = 0.03 + 3.75 * (0.1325 - 0.03)

re = 0.03 + 3.75 * 0.1025

re = 0.414375

Wa = 60%

Wb = 40%

The expected return of the portfolio:

E(R) = 0.60 * 0.229875 + 0.40 * 0.414375

E(R) = 0.137925 +0.16575

E(R) = 0.303675

E(R) = 30.37%