Question

Suppose Intel stock has a beta of 1.53​, whereas Boeing stock has a beta of 0.91. If the​ risk-free interest rate is 3.5% and the expected return of the market portfolio is 10.9%​, according to the​ CAPM,

a. What is the expected return of Intel​ stock? Answer in percentage

b. What is the expected return of Boeing​ stock? Answer in percentage

c. What is the beta of a portfolio that consists of 60% Intel stock and 40% Boeing​ stock?

d. What is the expected return of a portfolio that consists of 60% Intel stock and 40% Boeing​ stock? (There are two ways to solve​ this.) (Answer in percentage)

Answer 1

a. The expected return on a stock is calculated using the Capital Asset Pricing Model (CAPM)

The formula is given below:

Ke=Rf+[E(Rm)-Rf]

where:

Rf=risk-free rate of return which is the yield on default free debt like treasury notes

Rm=expected rate of return on the market.

Rm-Rf= Market risk premium

= Stock’s beta

Ke= 3.5% + 1.53*(10.9% - 3.5%)

   = 3.5% + 1.53*7.4

   = 3.5% + 11.32%

   = 14.82%.

b.The expected return on a stock is calculated using the Capital Asset Pricing Model (CAPM)

The formula is given below:

Ke=Rf+[E(Rm)-Rf]

where:

Rf=risk-free rate of return which is the yield on default free debt like treasury notes

Rm=expected rate of return on the market.

Rm-Rf= Market risk premium

= Stock’s beta

Ke= 3.5% + 0.91*(10.9% - 3.5%)

   = 3.5% + 0.91*7.4

   = 3.5% + 6.73%

   = 10.23%.

c.Portfolio beta= 0.60*1.53 + 0.40*0.91

   = 0.9180 + 0.3640

   = 1.2820.

d.Expected return of portfolio= 0.60*14.82% + 0.40*10.23%

   = 8.8920% + 4.0920%

   = 12.8840 12.88%

In case of any query, kindly comment on the solution.