Question

1) The beta of Elsenore, Inc., stock is 1.7, whereas the risk-free rate of return is 0.07. If the expected return on the market is 0.16 , then what should investors expect as a return on Elsenore? Round answer to 4 decimal places and represent percentage as decimal

2) You have invested 40 percent of your portfolio in an investment with an expected return of 12 percent and 60 percent of your portfolio in an investment with an expected return of 20 percent. What is the expected return of your portfolio? Round to 3 decimal places and express percentage as a decimal

Answer 1

1). According to the CAPM,

Expected Return = Risk-free Rate + [Beta * (Expected Market Return - Risk-free Rate)]

= 0.07 + [1.7 * (0.16 - 0.07)]

= 0.07 + [1.7 * 0.09]

= 0.07 + 0.153 = 0.223, or 22.30%

2). Expected Portfolio Return = [Weight(i) * Return(i)]

=1

= [0.40 * 12%] + [0.60 * 20%]

= 4.80% + 12% = 16.80%