We Do Bankruptcies is a law firm that specializes in providing advice to firms i

Question

We Do Bankruptcies is a law firm that specializes in providing advice to firms in financial distress. It prospers in recessions when other firms are struggling. Consequently, its beta is negative, .1. a. If the interest rate on Treasury bills is 4% and the expected return on the market portfolio is 14%, what is the expected return on the shares of the law firm according to the CAPM? (Enter your answer as a whole percent.) Expected return % b. Suppose you invested 70% of your wealth in the market portfolio and the remainder of your wealth in the shares in the law firm. What would be the beta of your portfolio? (Round your answer to 2 decimal places.) Portfolio beta

Explanation / Answer

Answer a.

Risk-free rate = 4%
Market return = 14%
beta = -0.10

Expected Return = Risk-free Rate + beta * (Market return - risk-free rate)
Expected Return = 4% + (-0.10) * (14% - 4%)
Expected Return = 3.00%

Expected return on the share of law firm is 3.00%

Answer b.

Weight of Market Portfolio = 70%
Weight of Shares of Law Firm = 30%
beta of shares of law firm = -0.10
beta of market portfolio = 1.00

Beta of Portfolio = Weight of Market Portfolio* beta of market portfolio + Weight of Shares of Law Firm*beta of shares of law firm
Beta of Portfolio = 70%*1.00 + 30%*(-0.10)
Beta of Portfolio = 0.67

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