Suppose that the S&P 500, with a beta of 1.0, has an expected return of 12% and

Question

Suppose that the S&P 500, with a beta of 1.0, has an expected return of 12% and T-bills provide a risk-free return of 5%. a. What would be the expected return and beta of portfolios constructed from these two assets with weights in the S&P 500 of (i) 0; (ii) .25; (iii) .50; (iv) .75; (v) 1.0? (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Round your answers to 2 decimal places.) Expected return Beta (i) 0 % (ii) .25 % (iii) .50 % (iv) .75 % (v) 1.0 % b. How does expected return vary with beta? (Do not round intermediate calculations.) The expected return by % for a one unit increase in beta.

Explanation / Answer

i) Beta = 0, expected return = 5%

ii) beta = 0.25, expected return = 5% + 0.25*7% = 6.75%

iii) beta = 0.5, expected return = 5% + 0.5*7% = 8.5%

iv) beta = 0.75, expected return = 5% + 0.75*7% = 10.25%

v) beta = 1, expected return = 5% + 1*7% = 12%

Expected return increases by 7% for one unit increase in beta

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