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. 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 ...
  4. 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 ...
  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. Unlevered Beta

    A type of metric that compares the risk of an unlevered company ...
  6. Equity Risk Premium

    The excess return that investing in the stock market provides ...
Hot Definitions
  1. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  2. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  3. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  4. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  5. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  6. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
Trading Center