Question

You have been managing a $5 million portfolio that has a beta of 0.90 and a required rate of return of 15%. The current risk-free rate is 7.25%. Assume that you receive another $500,000. If you invest the money in a stock with a beta of 1.00, what will be the required return on your $5.5 million portfolio?

Answer 1

Ans :

As per CAPM model,

Expected return = Risk free return + Beta of portfolio *(Market return - Risk free return)

= 7.25 % + 0.909091 * (15-7.25) (from note 1)

= 7.25 % + 7.045455 %

= 14.29545 %

=14.29 %

Note : 1

a. Risk free return = 7.25%

b. Market return = 15 %

c. Beta for $ 5 million = 0.9

Beta for $ 0.5 million = 1

Beta of portfolio of $ 5.5 million = 0.9 * $ 5 million / $ 5.5 million + 1 * $0.5 million / $ 5.5 million

= 0.81818 + 0.090909

= 0.909091