Question

1.

The systematic risk principle states that the expected return on a risky asset depends only on which one of the following?

		Company-specific risk
		Diversifiable risk.
		Systematic risk
		Unsystematic risk

2).

A company's stock has a beta of 1.04, the risk-free rate is 4.25%, and the total market return is 9.75%. What is its required rate of return?

		4.25%
		9.97%
		11.95%
		12.83%

3).

An investor has a $100,000 stock portfolio. $32,000 is invested in a stock with a beta of 0.75 and the remainder is invested in a stock with a beta of 1.38. These are the only two investments in his portfolio. What is his portfolio’s beta?

		0.75
		1.18
		1.29
		1.38

Answer 1

Part 1:
Answer: Correct answer is "systematic risk"
Expected return on a risky asset depends only on systematic risk (also called as market risk) according to systematic risk principle.

Part 2:
Answer: Correct answer is 9.97%
Required rate of return=Risk free rate + Beta*(Market return-Risk free rate)
Given that, the risk free rate=4.25%, stock beta=1.04 and total market return is 9.75%. Substituting the values in the equation, we get:

Required rate of return=4.25%+1.04*(9.75%-4.25%)
=0.0425+1.04*(0.055)
=0.0425+0.0572
=0.0997 or 9.97%

Part 3:
Answer: Correct answer is 1.18
Total amount invested=$100,000
Amount invested in stock with a beta of 0.75=$32,000
Amount invested in stock with a beta of 1.38=$100,000-$32,000=$68000
Percentage of amount invested in stock with a beta of 0.75=$32,000/$100,000=0.32 or 32%
Percentage of amount invested in stock with a beta of 1.38=$68000/$100,000=0.68 or 68%

Portfolio beta=Beta of stock A*Percentage invested in stock A+Beta of stock B*Percentage invested in stock B
Portfolio beta=0.75*32%+1.38*68%
=0.75*0.32+1.38*0.68=0.24+0.9384=1.1784 or 1.18 (Rounded up to two decimal places)