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%
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 riskfree 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
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