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
The correct answer is: b)
Step 1. Find Portfolio Beta
Beta of the Portfolio
= 0.125 + 0.5 + 0.25 + 0
2. Find E(R)
E(R) = Rf + B(Rm - Rf)
= 3% + (0.875)(5%)
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.
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