Question

8. Problem 8.16 Click here to read the eBook: Risk in a Portfolio Context: The CAPM Click here to read the eBook: The Relationship Between Risk and Rates of Return Problem 8-16 CAPM and portfolio return You have been managing a $5 million portfolio that has a beta of 1.15 and a required rate of return of 10%. The current risk-free rate is 4.25%. Assume that you receive another $500,000. If you invest the money in a stock with a beta of 1.45, what will be the required return on your $5.5 million portfolio? Round your answer to two decimal places. %

Answer 1

Required return=risk free rate+beta*(market rate-risk free rate)

Currently:

10=4.25+1.15*(Market rate-4.25)

(10-4.25)=1.15*(Market rate-4.25)

Market rate=(10-4.25)/1.15+4.25

=9.25%

Hence required return for $500,000=4.25+1.45*(9.25-4.25)

=11.5%

Portfolio return=Respective return*Respective weight

=(5,000,000/5,500,000*10)+(500,000/5,500,000*11.5)

=10.14%(Approx).