Expected return
Weight of stock A = Amount investment in A / Total investment = $30,000 / $50,000 = 0.60
Weight of stock B = 1 - weight of stock A = 1 - 0.60 = 0.40
Expected return of portfolio E(Rp) = Expected return of A x Weight of A + Expected return of B x Weight of B
or, E(Rp) = 16% x 0.60 + 15% x 0.40 = 15.60%
Required return
First, we need the portfolio beta -
Portfolio beta = Beta of A x Weight of A + Beta of B x Weight of B
or, Portfolio beta = 1.2 x 0.60 + 0.8 x 0.40 = 1.04
Required return as per CAPM can be computed as -
Required Rp = Risk free rate + Portfolio beta x market risk premium = 6% + 1.04 x 9% = 15.36%
The portfolio is expected to perform at 15.6% against the required return of 15.36%. Since expected return is more than the required return, the stock portfolio is underpriced and investment is recommended.
Given the following information for the two stocks: Stock Expected Return Standard Deviation Investment Beta 16%...
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