Problem 2 (4 marks) You observe that the risk free rate of return is 2.5 percent...

Question

Question

Problem 2 (4 marks) You observe that the risk free rate of return is 2.5 percent and the market risk premium is 9 percent. Yo

business finance

Answer 1

Answer #1

Given that,

risk free rate Rf = 2.5%

Market Risk premium MRP = 9%

Investment in stock A = $5000

Investment in stock B = $15000

So, weight of stock A Wa = investment in A/(investment in A + investment in B) = 5000/(5000+15000) = 25%

Weight of stock B Wb = 1 - Wa = 1-0.25 = 75%

Beta of stock A Ba = 1.25

Beta of stock B, Bb = 1.5

So, Beta of the portfolio is weighted average beta of its assets

=> Beta of portfolio Bp = Wa*Ba + Wb*Bb = 0.25*1.25 + 0.75*1.5 = 1.4375

So, expected return on portfolio using CAPM model is

E(r) = Rf + beta*MRP

=> Expected return for this portfolio = 2.5 + 9*1.4375 = 15.44%

Answer 2

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