Simon is a portfolio manager at the Alpha-Beta investment company. He expects th

Question

Simon is a portfolio manager at the Alpha-Beta investment company. He expects the T-Bill rate to be 8% and the expected return on the market to be 18%. Simon lives in the CAPM world meaning that all CAPM assumptions and statements are valid. Would Simon hold a portfolio with the expected return of 15% and beta of 2? Please show your calculations and briefly comment on the result.

For the calculations, show your workings AND FORMULAS, not only the final result. Partial marks are available for correct steps and formulas.

Explanation / Answer

No. Using CAPM, E(R) = Rf + beta x (Rm - Rf)

For beta = 2, Rm = 18% and Rf = 8%

=> Expected Returns, E(R) = 8% + 2 x (18% - 8%) = 28%

If Simon's portfolio has an expected return of 15% with a beta of 2, he should sell it because the risk-reward isn't favorable.

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