Question

5. Stock x, stock Y, and the market have had the following returns over the past four years. х Y Market 11% Year 1999 2000 2001 2002 10% 4% 7% 12% -3% 21% -5% 17% 12% -3% -2% The risk-free rate is 7 percent. The market risk premium is 5 percent. What is the required rate of return for a portfolio that consists of $14,000 invested in Stock X and $6,000 invested in Stock y rates of return?

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

A B C D E F 1 Year X Y 2 3 4 5 6 7 1999 2000 2001 2001 Market 11% 7% 17% -3% 10% 4% 12% -2% 12% -3% 21% -5% 8 0.74 Beta of X Beta of Y 1.33 Risk free rate Market risk premium 7% 5% Portfolio: 9 10 11 12 13 14 15 16 17 18 19 20 Weight 0.70 Beta 0.74 Stock X Stock Y Value $14,000 $6,000 $20,000 0.30 1.33 Portfolio's Beta 0.92 Required rate of return of Portfolio 11.58% 21 22 23 24

Cell reference -

A B с D E F 1 Year Market х Y 1999 0.11 0.1 2 3 4 5 6 7 2000 2001 0.07 0.17 0.04 0.12 0.12 -0.03 0.21 2001 -0.03 -0.02 -0.05 8 9 Beta of X Beta of Y =SLOPE(D3:06,C3:06) =SLOPE(E3:E6,C3:06) Risk free rate Market risk premium 0.07 0.05 Portfolio: Stock X Stock Y 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Value 14000 6000 =SUM(C15:C16) Weight Beta =C15/$C$17 =C8 =C16/$C$17 =C9 Portfolio's Beta =SUMPRODUCT(D15:016,E15:E16) Required rate of return of Portfolio =C11+C19*C12

Hope it will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.