Suppose that many stocks are traded in the market and that it is possible to bor

Question

Suppose that many stocks are traded in the market and that it is possible to borrow at the risk-free rate, rƒ. The characteristics of two of the stocks are as follows:

Calculate the expected rate of return on this risk-free portfolio? (Hint: Can a particular stock portfolio be substituted for the risk-free asset?) (Round your answer to 2 decimal places.)

Could the equilibrium rƒ be greater than 7.50%?

Suppose that many stocks are traded in the market and that it is possible to borrow at the risk-free rate, rƒ. The characteristics of two of the stocks are as follows:

Explanation / Answer

a)

0=[0.25 WA - 0.75(1-WA)]

0=0.25WA - 0.75 + 0.75WA

WA = 0.75

The expected rate of return on this risk free portfolio is:

E(R) = 0.75*6%+0.25*12%

        = 4.5%+3%

       = 7.5%

b)

No, risk free rate must be equal

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