The risk-free rate is 6% and the market risk premium is 5%. Your $1 million port

Question

The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT? ?Answer
a. If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%.
b. If the market risk premium remains unchanged but expected inflation
increases by 2%, your portfolio's required return will increase by more than 2%.
c. The portfolio's required return is less than 11%.
d. The required return on the market is 10%.
e. If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11%.

? Taggart Inc.'s stock has a 50% chance of producing a 21% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return? ?Answer
a. 9.72%
b. 7.82%
c. 7.90%
d. 8.37%
e. 9.88%

? Tom O'Brien has a 2-stock portfolio with a total value of $100,000. $75,000 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's beta? ?Answer
a. 0.81
b. 0.92
c. 1.12
d. 0.86
e. 0.99

Explanation / Answer

a) Statement-a is true becasue if we calculate the portfolio expected return, we are getting 11.4%. If there is 2% increase in market risk premium and the risk free rate remains unchanged, then the portfolio return is 13.56%. Therefore, the percentage change in the portfolio expected return is 19% which is more than 2%. b) Calculating the expected rate of return: E(R) = 0.50 * 0.21 + 0.30 * 0.10 + 0.20 * (-0.28)         = 0.079 or 7.9% The correct option is c) 7.9% c) Weight of stockA is ($75,000 / $100,000) = 0.75     Weight of StockB is ($25,000 / $100,000) = 0.25 POrtfolio beta = 0.75 * 0.75 + 0.25 * 1.42                       = 0.9175 or 0.92 Therefore, the correct option is b) 0.92

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