Year StockL Market 2005--- 12.00%----- 14.00% 2006--- 5.00% --- 2.00% 2007--- 11
ID: 2662632 • Letter: Y
Question
Year StockL Market
2006--- 5.00% --- 2.00%
2007--- 11.00%------ 14.00%
2008--- -7.00% ------ -3.00%
Additional Information:
60% of your portfolio is invested in Stock L and the remaining40% is invested in Stock Y. The risk-free rate is 6% and themarket risk premium is also 6%. You estimated that 14% is therequired rate of return on your portfolio. While Stock L hasthe beta of 0.9484.
Required:
You are required to calculate the beta of StockY?
Explanation / Answer
According to the given data,
Beta (L) for Stock L is = 0.9484
Risk-free rate (Rf) = 6%
Weight of Stock L is 60%
Weight of Stock Y is 40%
Market risk premium is (E[Rm]- Rf) is6%
Expected market return E[Rm] = 14%
We know that the SML equation is expressed as follows
E [Ri] = Rf + (E[Rm]-Rf)p
By substituting the given values in the given formula, weget
0.14 = 0.06 + (0.06) x p
p = 0.08 / 0.06 = 1.33
To find out the value of for Stock Y,
p = Weight of Stock L (Beta of stock L) +Weight of Stock Y (Beta of stock Y)
1.33 = 0.6 (0.9484) + 0.4 (Beta of stock Y)
Beta of stock Y = (1.33 – 0.57) / 0.4 = 1.9
Conclusion: Therefore, the value of beta for stock Y is1.9 which indicates that the stock is risky.
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