1.You invest 30% of funding in Stock M and the rest in Stock N. The return...

1.You invest 30% of funding in Stock M and the rest in Stock N. The return on Stock M is 12% and its standard deviation is 7%. The return on Stock N is 25% with a standard deviation of 11%. Assume the two stocks have a correlation coefficient of 0.3. Calculate this portfolio’s return and standard deviation.

2. If you invest your money in 3 stocks: A, B, C. Each stock has a return of 11%,15%, and 21%. Your funding allocation on the stocks is: 30:30:40. Calculate your portfolio return.

3. Suppose you own a portfolio that has a beta risk of 1.2. Treasury bond yield is assumed to be 5%, and the stock market return on average is 11%. What should be your required return on this portfolio if you use CAPM in your estimation? What is the stock market risk premium? What is your portfolio’s risk premium?

Please show work and explain answers.

Expert Solution

1. Portfolio's Return =Weight of Stock M *Return of Stock M + Weight of Stock N*Return of stock N =30%*12%+70%*25% =21.10%
Standard Deviation=((Weight of Stock M*Standard Deviation of M)^2+(Weight of Stock N*Standard Deviation of N)^2+2*Weight of Stock M*Standard Deviation of M*Weight of Stock N*Standard Deviation of N*Correlation)^0.5
=((30%*7%)^2+(70%*11%)^2+2*30%*70%*7%*11%*0.3)^0.5 =8.57%

2. Portfolio Return =30%*11%+30%*15%+40%*21% =16.20%

3. Required Return using CAPM =Risk free Rate + Beta*(Market Return-Risk free Rate)
=5%+1.2*(11%-5%) =12.20%
Stock Market Risk premium =11%-5% =6%
Portfolio Risk Premium =12.20%-5% =7.20%

jeff jeffy answered 2 years ago

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