Question

Answer the following question based on the following information: An investor is considering the following three stocks to invest. Suppose that the current T-bill rate is 5% and the market rate of return is 13%.

Stock A Stock B Stock C Beta

1.3 1.0    0.7

Suppose that the investor has invested $100,000 in stock A and $100,000 in stock B. How much should he/she invest in stock C so that he/she can expect 14% rate of return from the portfolio?

Group of answer choices

$5,124.76

$9.090.91

$0.00

$12,564.94

$11,764.71

Answer 1

Step 1 :	Expected Rate of return of stock A
	R = Rf+ B(Rm-Rf)
	Where,
	Rf = Risk Free Return
	B= Beta
	Rm-Rf= Risk Premium
	=0.05+1.3*(0.13-0.05)
	=0.05+1.3*(0.08)
	=15.4 %
Step 2:	Rate of return of stock B
	R = Rf+ B(Rm-Rf)
	Where,
	Rf = Risk Free Return
	B= Beta
	Rm-Rf= Risk Premium
	=0.05+1*(0.13-0.05)
	=0.05+1*(0.08)
	=13 %
Step 3 :	Expected Rate of return of stock C
	R = Rf+ B(Rm-Rf)
	Where,
	Rf = Risk Free Return
	B= Beta
	Rm-Rf= Risk Premium
	=0.05+0.7*(0.13-0.05)
	=0.05+0.7*(0.08)
	=10.6 %
Step 4:	Portfolio return is the weighted average return on its stock
	to calculate amount we can form following equation
	Let us assume amount to be invested be X
	0.14 =[0.154*100000/(200000+X)]+[0.0.13*100000/(200000+X)]+[0.106*X/(200000+X)]
	On solving equation we get
	X =11764.71
	Correct Answer = $11764.71