Question

Use the following information to answer the question(s) below. Portfolio Correlation w/ Firm Weight Volatility Market Portfolio Taggart Transcontinental 0.25 14% 0.7 Wyatt oil 0.35 18% 0.6 Rearden Metal 0.40 15% 0.5 The volatility of the market portfolio is 10%, the expected return on the market is 12%, and the risk-free rate of interest is 4%. estion The expected return for Rearden Metal is closest to: Select one: A. 11.8% B. 11.4% C. 10.0% D. 12.0%

Answer 1

Standard deviation (volatility) of Market portfolio(MP)= 10%

Standard deviation (volatility) of Rearden Metal(RM) = 15%

Correlation of Rearden Metal with Market portfolio = 0.5

Covariance(RM,MP) = (Correlation of RM with MP)*(SD of MP)*(SD of RM)

= 0.5*15*10

= 75

Beta of Rearden Metal = Covariance(RM,MP)/(SD of MP)^2

= 75/(10*10)

= 0.75

Now, Calculating the Expected return of Rearden Metal using CAPM model:

Expected Return = R + B(Rm – R)

Rf = Risk free Return = 4%

Rm = Market return = 12%

B = Betaof Stock = 0.75

Expected Return = 4% + 0.75(12%-4%)

= 10%

hence, Option C. 10%