Question

Assume that CAPM holds, i.e. ri = ro+ B;(PM-ro) where Bi portfolio of stocks X, Y, and the risk-free asset. The beta of the portfolio is Bp a beta of 1.5 and Y has a beta of 2.0. Expected return of Y is 10% more than the expected return of X. Risk-free rate is 5%. What is the expected return of this portfolio? iM Your goal is to create a 0.7. X has

Answer 1

Risk premium is Return of market - Risk free rate (R0)
Expected return of Y is 10% more than Expected Return of X.      

Rm-R0 = Dffference in Expected return of two stocks/Differnce in betas      
Rm - 5% = (10%)/(2.0-1.5)      
Rm - 5%=(10%)/(2-1.5)   20.00%  
Rm = 20%+5% =   25.00%  

Expected return of Portfolio as per Capm = R0 + Bp*(Rm-R0)      
Beta of portfolio is    0.7  
So expected Return of portfolio = 5% + (0.7*(25%-5%))      
19.00%      

So Expected Return of this portfolio is   19.00%  

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