Question

Question 1: You invest in a portfolio of 5 stocks with an equal investment in each one. The betas of the 5 stocks are as follows: .8, -1.3, .95, 1.2 and 1.4. The risk-free return is 3% and the market return is 7%. A. Compute the beta of the portfolio.

B. Compute the required return of the portfolio.

Question 2: You are given the following probability distribution for a stock:

Probability       Outcome            

     .5                     -6%        .5                    18%

Answer 1

Pb 1A:

Portfolio Beta is weighted Avg beta of securities in that portfolio

Security	Weights	Beta	Wtd Beta
1	0.2000	0.80	0.1600
2	0.2000	-1.30	-0.2600
3	0.2000	0.95	0.1900
4	0.2000	1.20	0.2400
5	0.2000	1.40	0.2800
Portfolio Beta			0.6100

Part 1B:

SML Ret or CAPM Ret or Required Ret = Rf + Beta ( Rm - Rf )
Rf = Risk free ret
Rm = Market ret
Rm - Rf = Risk Premium
Beta = Systematic Risk

Beta Specifies Systematic Risk
Systematic risk specifies the How many times security return will deviate to market changes.
SML return considers the risk premium for Systematic risk alone.Where as CML return considers risk premium for Total risk.
Beta of market is "1".

Particulars	Amount
Risk Free Rate	3.0%
Market Return	7.0%
Beta	0.6100
Risk Premium ( Rm - Rf)	4.00%

SML Return = Rf + Beta ( Rm - Rf )
= 3 % + 0.61 ( 4 % )
= 3 % + ( 2.44 % )
= 5.44 %

Part 2:

Expected Ret = Sum [ Prob * Ret ]

Scenario	Prob	Ret	Prob * Ret
1	0.5000	-6.00%	-3.00%
2	0.5000	18.00%	9.00%
Expected Ret			6.00%