Q:

A manager wishes to construct a portfolio by investing 25% in a stock half as volatile as the market, 25% in a stock twice as volatile as the market, 25% in the market itself, and finally, 25% into Treasury bills. If the market risk premium is 5% and the risk free rate is 3%, what's the expected return from this portfolio?
a) 6.75%
b) 7.38%
c) 8.00%
d) 4.75%

A:

The correct answer is: b)
Step 1. Find Portfolio Beta
Beta of the Portfolio
= (.25)(.5)+(.25)(2)+(.25)(1)+(.25)(0)
= 0.125 + 0.5 + 0.25 + 0
= 0.875

Step 2. Find E(R)
E(R) = Rf + B(Rm - Rf)
= 3% + (0.875)(5%)
= 7.38%
Note that the market risk premium is the difference between the expected market return on a market portfolio, and the risk-free rate. In this case, we were given the market risk premium, so further calculation was not needed.
2005 CFA Level 1 LOS: 12.1.D.h


RELATED FAQS

  1. How does beta measure a stock's market risk?

    Learn how beta is used to measure risk versus the stock market, and understand how it is calculated and used in the capital ...
  2. Stock A has a standard deviation of 16% and a beta of 1.1 ...

    The correct answer is: C) Step 1: Calculate the expected return on Stock A E(R) = (.10)(12%) + (.25)(15%) + (.40)(8%) + (.25)(-9%) ...
  3. How does Beta reflect systematic risk?

    Learn what systematic risk is, what beta is and how it is related to market indexes, and how beta reflects the systematic ...
  4. What are the differences between delta hedging and beta hedging?

    Learn about hedging strategies, how to delta and beta hedge a security and the difference between delta hedging and beta ...
  5. What is the best way to diversify an investment portfolio?

    Learn which methods investors use to diversify their portfolios and how risk tolerance plays a big role in determining the ...
  6. What percentage of a diversified portfolio should be invested in the financial services ...

    Learn about how investors use their assessed risk tolerance to determine what percentage of their portfolios should be invested ...
RELATED TERMS
  1. Beta

    Beta is a measure of the volatility, or systematic risk, of a ...
  2. International Beta

    Better known as "global beta", international beta is a measure ...
  3. High Beta Index

    An index composed of companies with high betas trading on the ...
  4. Treynor Index

    A measure of risk-adjusted performance of an investment portfolio. ...
  5. Portable Alpha

    A strategy in which portfolio managers separate alpha from beta ...
  6. Equity Risk Premium

    The excess return that investing in the stock market provides ...

You May Also Like

Hot Definitions
  1. Return On Invested Capital - ROIC

    A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. ...
  2. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  3. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  4. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  5. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  6. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
Trading Center