Final answer:
The expected return on the equally weighted portfolio with ABC stock (beta of 1.6) and XYZ stock (beta of -0.8) is 8.8%, calculated using the CAPM formula with a risk-free rate of 6% and market risk premium of 7%.
Step-by-step explanation:
The expected return on the portfolio consisting of two stocks held in equal weights, with ABC stock having a beta of 1.6 and XYZ stock a beta of -0.8, can be calculated using the Capital Asset Pricing Model (CAPM). Given the risk-free rate of 6% and the market risk premium of 7%, we first calculate the expected returns of each stock using the formula:
Expected Return = Risk-Free Rate + (Beta × Market Risk Premium)
For ABC: 6% + (1.6 × 7%) = 17.2%
For XYZ: 6% - (0.8 × 7%) = 0.4%
The portfolio's expected return is the average of these two, as the stocks held in equal weights:
Portfolio Return = (17.2% + 0.4%) / 2 = 8.8%
Thus, the expected return on the portfolio would be 8.8%.