Question

An investor is forming a portfolio by investing $50,000 in stock A which has a beta of 1.50, and $25,000 in stock B which has a beta of 0.90. The return on the market is equal to 6 percent and Treasury bonds have a yield of 4 percent. What is the required rate of return on the investor’s portfolio?

Answer 1

6.6%

Step-by-step explanation:

For computing the required rate of return, first we have to determine the weights of stock A and stock B and portfolio beta which is shown below:

Stock A weighatge = Invested amount ÷ total amount

= $50,000 ÷ $75,000

= 0.66667

Stock B weighatge = Invested amount ÷ total amount

= $25,000 ÷ $75,000

= 0.333333

Total amount = $50,000 + $25,000 = $75,000

Now multiply the weighatge into its beta

= Stock A weighatge × stock A beta + Stock B weighatge × stock B beta

= 0.66667 × 1.50 + 0.333333 × 0.90

= 1 + 0.30

= 1.30

Now the required rate of return would be

Expected rate of return = Risk-free rate of return + Beta × (Market rate of return - Risk-free rate of return)

= 4% + 1.30 × (6% - 4%)

= 4% + 1.30 × 2%

= 4% + 2.6%

= 6.6%