Check My Work (3 remaining) O Click here to read the eBook: Risk in a Portfolio

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Check My Work (3 remaining) O Click here to read the eBook: Risk in a Portfolio Context: The CAPM Click here to read the eBook: The Relationship Between Risk and Rates of Return sCAPM AND PORTFOLIO RETURN 11%. The curent risk.free rate is SSO% Assume that you receve You have been managing a $5 million portfolio that has a beta of 0.90 and a required rate of return of o another $500,000. If you invest the money in a stock with a beta of 0.70, what will be the required return on your $5.,5 milion portfelio? Do not round intermedlate 1o. Round your answer to two decimal places g88. 2

Explanation / Answer

First calculate the market risk premium (MRP) as per CAPM:

Return on existing portfolio = Risk free rate + Beta x Market risk premium

11% = 5.5% + 0.9 x MRP

MRP = (11%-5.5%)/0.9

MRP = 6.1111%

Now, we can get return on new investment in stock:

Return on new stock = Risk free rate + Beta of new stock x MRP

Return on new stock = 5.5% + 0.7 x 6.1111%

Return on new stock = 9.7778%

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Now we can calculate portfolio return after addition of new stock:

Weight of old portfolio = 5 million /5.5 million = 5/5.5 ; Weight of new stock to portfolio = 0.5/5.5

.

Required return = Old portfolio return x Weight of old portfolio to new + Return on new stock x Weight of new stock

Required return = 11% x 5/5.5 + 9.7778% x 0.5/5.5

Required return = 10.89%

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