Question

You form a portfolio by investing 55% of your money in a risky stock with a beta of 1.4 and the rest of your money in a risk-free asset. The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to capital asset pricing model (CAPM), the expected return of the resulting portfolio is:

A.

10.62%

B.

14.40%

C.

9.78%

D.

9.30%

E.

6.60%

Answer 1

The expected return on portfolio is computed as shown below:

= Percentage invested in risky stock x expected return of stock + Percentage invested in risk free asset x return of risk free asset

Expected return on stock is computed as follows:

= risk free asset + beta x ( return on market - risk free asset)

= 0.06 + 1.4 ( 0.12 - 0.06)

= 14.4%

So, the expected return will be as follows:

= 0.55 x 0.144 + (1 - 0.55) x 0.06

= 0.55 x 0.144 + 0.45 x 0.06

= 0.0792 + 0.027

= 10.62%

So, the correct answer is option A.

Feel free to ask in case of any query relating to this question

answered by: anonymous