Consider the following information for three stocks, A, B, and C. The stocks’ re

Question

Consider the following information for three stocks, A, B, and C. The stocks’ returns are positively but not perfectly positively correlated with one another, i.e., the correlations are all between 0 and 1. Expected Standard Stock Return Deviation Beta A 10% 20% 1.0 B 10% 10% 1.0 C 12% 12% 1.4 Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns What is portfolio ABC/s expected rate of return?

Explanation / Answer

Stock Expected Return Sd Beta A 10% 20% 1 B 10% 10% 1 C 12% 12% 1.2 EXPECTED RETURN OF PORTFOLIO ABC STOCK WEIGHT (1) Expected return (2) Expected return of portfolio (1*2) A 0.333333 10% 3% B 0.333333 10% 3% C 0.333333 12% 4% Expected return of portfolio ABC 11%

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