Question

6. Mike’s brokerage account is highly correlated to the market. In fact the account has a correlation with the market of about 99 percent. However, because Mike has some leveraged mutual funds in the account, the beta of the portfolio is approximately 20 percent greater than the market. Mike’s brokerage account is a margin account, which has an initial margin of 50 percent and a maintenance margin of 35 percent.

How much does this account yield yearly if the amount invested is $70,000

Answer 1

Amount invested is $70,000 which is 85% of actual holding (because margin account)

Therefore, Actual holdings will be 70,000/85% = $82,352.94

It is given that due to leverage, beta is approximately 20% greater than market and there is 99% correlation with the market.

Therefore, approximate beta of Unlevered Portfolio i.e. Actual Holdings will be

82352.94 × B/70000 = 1.2B

Therefore, B = 1.02

Therefore, Beta of unlevered portfolio i.e. actual holdings is 1.02 and Beta of actual investment will be 1.2.

Therefore, Yearly Yield will be approximately 20% greater than market yield.

Note: From given data, actual return cannot be calculated in absolute terms. Also, the information "beta of portfolio is 20 percent greater than market" is enough to give the answer of yield.