Question

1. Consider the following portfolio of four stocks:

Security                                                Weight                 Beta

ABC                                        .167                        3.09

DEF                                        .25                          0.63

GHI                                        .233                        1.54

JKL                                          .35                          1.81

The 25 - year government of Canada bond has a yield of 2%

The market risk premium is 5%

What is the portfolio beta?

What is the expected return of each security?

Answer 1

The portfolio beta is computed as follows:

= Beta of security ABC x weight of security ABC + Beta of security DEF x weight of security DEF + Beta of security GHI x weight of security GHI + Beta of security JKL x weight of security JKL

= 3.09 x 0.167 + 0.63 x 0.25 + 1.54 x 0.233 + 1.81 x 0.35

= 0.51603 + 0.1575 + 0.35882 + 0.6335

= 1.66585

Expected return of security ABC is computed as follows:

= Risk free rate + Beta x Market risk premium

= 2% + 3.09 x 0.05

= 2% + 15.45%

= 17.45%

Expected return of security DEF is computed as follows:

= Risk free rate + Beta x Market risk premium

= 2% + 0.63 x 0.05

= 2% + 3.15%

= 5.15%

Expected return of security GHI is computed as follows:

= Risk free rate + Beta x Market risk premium

= 2% + 1.54 x 0.05

= 2% + 7.7%

= 9.7%

Expected return of security JKL is computed as follows:

= Risk free rate + Beta x Market risk premium

= 2% + 1.81 x 0.05

= 2% + 9.05%

= 11.05%

Please ask in case of any doubts.