Question

A portfolio that combines the risk-free asset and the market portfolio has an expected return of 7.7 percent and a standard deviation of 10.7 percent. The risk-free rate is 4.7 percent, and the expected return on the market portfolio is 12.7 percent. Assume the capital asset pricing model holds.

What expected rate of return would a security earn if it had a .52 correlation with the market portfolio and a standard deviation of 55.7 percent? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Expected rate of return             %

Answer 1

Standard deviation of market portfolio=10.7%/(7.7%-4.7%)/(12.7%-4.7%)=28.533%

Expected rate of return the security would earn=4.7%+(12.7%-4.7%)*0.52*55.7%/28.533%=12.821%