Question

you have a portfolio of two stocks held in equal weights. the abc stock has a beta of 1.6, and the xyz stock has a beta of -0.3. the risk free rate is 5% and the market risk premium is 8%. what is the return on the portfolio?

Answer 1

The expected return on the portfolio is calculated using the CAPM formula for each stock and then averaging the two results because the stocks are held in equal weights. The expected return on the portfolio is 10.2%.

Step-by-step explanation:

The student's question is about calculating the expected return on a portfolio consisting of two stocks with different betas. To solve this, we'll use the Capital Asset Pricing Model (CAPM), which states that the expected return on a stock is equal to the risk-free rate plus the stock's beta times the market risk premium.

The formula for CAPM is: Expected Return = Risk-Free Rate + (Beta × Market Risk Premium)

First, we'll calculate the expected return for each stock. For ABC stock with a beta of 1.6:

Expected Return ABC = 5% + (1.6 × 8%) = 5% + 12.8% = 17.8%

For XYZ stock with a beta of -0.3:

Expected Return XYZ = 5% + (-0.3 × 8%) = 5% - 2.4% = 2.6%

Since the stocks are held in equal weights, the expected return of the portfolio is the average of the two individual returns:

Expected Return Portfolio = (17.8% + 2.6%)/2 = 10.2%

Therefore, the expected return on the portfolio is 10.2%.