Use the following information to answer the question(s) below. Suppose that all

Question

Use the following information to answer the question(s) below.

Suppose that all stocks can be grouped into two mutually exclusive portfolios (with each stock appearing in only one portfolio): growth stocks and value stocks. Assume that these two portfolios are equal in size (market value), the correlation of their returns is equal to 0.6, and the portfolios have the following characteristics:

The risk free rate is 3.5%.


The expected return on the market portfolio (which is a 50-50 combination of the value and growth portfolios) is closest to:

a. 19.0%

b. 15.0%

c. 12.0%

d. 13.5%

Explanation / Answer

Expected return on market portfolio = Weight of value stock * return of value stock + weight of growth stock * value of growth stock

Expected return on market portfolio = 0.5 * 0.12 + 0.5 * 0.15

Expected return on market portfolio = 0.06 + 0.075

Expected return on market portfolio = 0.135 or 13.5%

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