Question

You own a portfolio that has a total value of 129,000 dollars. The portfolio has 6,000 shares of stock A, which is priced at 7.6 dollars per share and has an expected return of 11.87 percent. The portfolio also has 10,000 shares of stock B, which has an expected return of 15.29 percent. The risk-free return is 4.09 percent and inflation is expected to be 1.53 percent. What is the risk premium for your portfolio? Answer as a rate in decimal format so that 12.34% would be entered as .1234 and 0.98% would be entered as .0098.

Answer 1

Portfolio value = $129,000

Stock A value = 6,000 shares * $7.6

Stock A value = $45,600

Stock B value = Total value - Stock A value

= 129,000 - 45,600

Stock B value = $83,400

Stock A expected return = 11.87%

Stock A expected return = 15.29%

Portfolio expected return = Wa * return + Wb* return (w = weights)

Portfolio expected return = 45,600/129,000*11.87% + 83,400/129,000 *15.29%

Portfolio expected return = 14.081%

Risk premium of portfolio = Portfolio expected return - risk free rate

In this case, risk free return is not clear whether is nominal or real risk free rate. I will compute with two cases

Nominal risk free rate = 4.09%

Inflation = 1.53%

Real risk free rate = 4.09% - 1.53% = 2.56%

Risk premium of portfolio = Portfolio expected return - Nominal risk free rate

= 14.081% - 4.09% = 9.991% or 0.09991

Risk premium of portfolio = Portfolio expected return - Real risk free rate

= 14.081% - 2.56% = 11.521% = 0.11521

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