In: Finance
Assume the market risk is 8% and risk-free rate is 2%. You have a portfolio with $15,000 invested in Stock A with a beta of 1.2, $8,000 in Stock B with a beta of 1.8, and $12,000 in Stock C with a beta of 2.0. What is the beta and expected return of the portfolio?
Given about a portfolio,
Investment in stock A = $15000
Beta of stock A, Ba = 1.2
Investment in stock B = $8000
Beta of stock B, Bb = 1.8
Investment in stock C = $12000
Beta of stock C, Bc = 2.0
Total investment is (Investment in stock A + Investment in stock B + Investment in stock C)
=> total investment = 15000 + 8000 + 12000 = $35000
Weight in stock A, Wa = investment in stock A/total investment = 15000/35000 = 0.4286 or 42.86%
Weight in stock C, Wb = investment in stock B/total investment = 8000/35000 = 0.2286 or 22.86%
Weight in stock C, Wc = investment in stock C/total investment = 12000/35000 = 0.3428 or 34.28%
So, beta of portfolio is weighted average beta of stock = Wa*Ba + Wb*Bb + Wc*Bc
=> Beta of portfolio = 0.4286*1.2 + 0.2286*1.8 + 0.3428*2 = 1.61
So, Beta of portfolio is 1.61
Risk free rate Rf = 2%
Market risk premium MRP = 8%
So, expected return on stock using CAPM = Rf + beta*MRP
=> Expected return of the portfolio = 2 + 1.61*8 = 14.89%