Question

1. (6 pts) You have an $80,000 portfolio of large-cap stocks.  They consists of the following:

Portfolio of large cap stocks:

Stock                beta                  Dollar amount               
Wal-mart          0.70                  $20,000
IBM                 1.15                  $10,000
PG                   0.80                  $50,000
                        Total                $80,000

1. What is the beta of your portfolio?               

Portfolio Beta = _____________

2. If the current money market rate is 1.2% and the market risk premium is 7.5%, what is the required rate of return for your large cap stock portfolio?

Required Rate of Return = _____________

2. (2 pts) An option contract represents an option on ___________ shares of stock. (a number)

Answer 1

1.a) Answer

Total investment = $ 80,000

Portfolio Beta = (Walmart dollar amount / Total investment) x Beta of Walmart + (IBM dollar amount / Total investment) x Beta of IBM + (PG dollar amount / Total investment) x Beta of PG

Portfolio Beta = ( $ 20,000 / $ 80,000) x 0.70 + ( $ 10,000 / $ 80,000) x 1.15 + ( $ 50,000 / $ 80,000) x 0.80

= 0.175 + 0.14375 + 0.5

= 0.819

Therefore, Portfolio Beta = 0.819

b. answer

Market rate = 1.2%

Risk premium = 7.5%

Beta of the portfolio = 0.819

Required rate of return = Rf + Beta ( Risk premium)

Where, Risk premium = Rm - Rf

Required rate of return = 1.2% + 0.819 x 7.5%

= 7.3%

Therefore, Required rate of return = 7.3 %

2. Answers

The options are usually traded in units called contracts. An option contract ia an agreement between two parties i.e,. the buyer and seller, to buy or sell the underlying asset at a specified price and also before expiration time. The options can be call option and put option. In option contract, one option represent 100 shares of the underlying stock. The options are quoted per share basis.