Consider the following information for three stocks, Stocks X, Y, and Z. The ret

Question

  Consider the following information for three stocks, Stocks X, Y, and Z.  The returns on the three stocks are positively correlated, but they are not perfectly correlated.  (That is, each of the correlation coefficients is between 0 and 1.)

Fund Q has one-third of its funds invested in each of the three stocks. The risk-free rate is 5.5%, and the market is in equilibrium. (That is, required returns equal expected returns.)  

Stock Expected Return Standard Deviation Beta X 9.96 % 16 % 0.9 Y 11.94
16
1.3 Z 13.92
16
1.7

Explanation / Answer

1.rx = rF+ beta*(rM - rRF)

9.96% = 5.5% +0.9*(rM - rRF)

market risk premium (rM - rRF)= 4.96%

2. beta of Fund Q =(0.9 +1.3+1.7)/3 = 1.30

3.expected return of Fund Q =(9.96%+11.94% +13.92%)/3 =11.94%

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