The risk-free rate of return is 4.2 percent and the market risk premium is 14 pe

Question

The risk-free rate of return is 4.2 percent and the market risk premium is 14 percent. What is the expected rate of return on a stock with a beta of 1.5? 12.60 percent 20.30 percent 10.15 percent 25.20 percent 21.00 percent You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.35 and the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio? (Round your answer to 2 decimal places, (e.g., 32.16)) Portfolio beta Your portfolio has a beta of 1.27. The portfolio consists of 13 percent U.S. Treasury bills, 27 percent stock A, and 60 percent stock B. Stock A has a risk level equivalent to that of the overall market. What is the beta of stock B? 0.60 1.67 0.87 4.70 1.27

Explanation / Answer

SOLUTION:

1. Calculation of Risk-free return.

Risk-free return = Risk free rate + Beta (Market risk premium)

Risk-free return = 4.2 + 1.5 (14)

Risk-free return = 25.20%

2. Calculation of portfolio beta.

We know that the portfolio is equally weighted with 3 components. So each have a weight of 33.33%

The risk free asset has no correlation to the market portfolio and therefor is given a beta of 0

Portfolio Beta = (weight asset 1 * Beta 1) + (weight asset 2 * Beta 2) + (weight risk free asset * Beta risk free asset)

1 = (0.3333 * B1) + (0.3333 * 1.35) + 0

1

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