A manager wishes to construct a portfolio by investing 25% in a stock half as volatile as the market

By Investopedia Staff AAA
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. Demonstrate, using equations from the Dupont or similar ratio model ...

    The key to this question is the relationship between margins and turns in the ROE portion of ratio models and formulas. ROE ...
  2. Which of the following strategies is (are) appropriate? I. If a borrower has a fixed ...

    The correct answer is: a) (II) is incorrect because if an investor has floating rate assets and is expecting interest rates ...
  3. John King, a CFA, resides in Jurisdiction A, where the securities laws and regulations ...

    The correct answer is d. Since the Law of Locality applies, and King performs his business in Jurisdiction B (where securities ...
  4. For $800,000 invested today, an insurance company promises to start making perpetual ...

    The correct answer is: A) We must first link the $800,000 today to the period when the perpetuity payments will begin. In ...
RELATED TERMS
  1. No results found.

You May Also Like

Related Articles
  1. No results found.
Trading Center