25) Laura has one risk-free asset and one risky stock in her portfolio. The risk

Question

25) Laura has one risk-free asset and one risky stock in her portfolio. The risk-free asset has an expected return of 3.2 percent. The risky asset has a beta of 1.3 and an expected return of 14.9 percent. What is the expected return on the portfolio if the portfolio beta is 0.975? A) 7.65 percent B) 9.83 percent C) 10.73 percent D) 11.98 percent E) 12.37 percent 26) Wilson Farms' stock has a beta of.84 and an expected return of 7.8 percent. The risk-free rate is 2.6 percent and the market risk premium is 6 percent. This stock is CAPM return for the stock is A) undervalued; 7.34 B) undervalued; 7.49 C) undervalued; 7.64 D) overvalued; 7.34 E) overvalued; 7.49 because the percent.

Explanation / Answer

25.

Beta of risky Assets = 1.30

Beta of risk free assets = 1.30

Beta of portfolio = 0.975

Suppose weight of risky assets is W and beta of risk free assets is (1 - W)

0.975 = (W × 1.30) + (1 - W) × 0

W = 0.975 / 1.30

= 75%

So, weight of risky assets in portfolio is 75% and Weight of risk free assets is 25%.

Expected return of portfolio = (75% × 14.90%) + (25% × 3.20%)

= 11.18% + 0.80%

= 11.98%

Expected return of portfolio is 11.98%.

Option (D) is correct answer.

26.

Required rate of return = RIsk free rate + (risk premium × Beta)

= 2.60% + (6% × 0.84)

= 2.60% + 5.04%

= 7.64%

Required rate of return on company stock is 7.64%. Expected return is 7.80%. Since, Expected return is more than required rate of return, so stock is undevalued.

Option (C) is correct answer.

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