Use the following to answer question 4: Security Return Standard Deviation Beta

Question

Use the following to answer question 4:

            Security                        Return    Standard Deviation                Beta

            A                                 15%                 8%                               1.2

            B                                  12%                 14%                             0.9

            Risk-free asset              5%                   0                                  0

      4.   What is the portfolio expected return with 125% invested in A and the difference in the risk-free asset via borrowing at the risk-free interest rate (Hint: The weight could be negative as long as the sum of the weights equals 1)?

     A)   9.8%

     B)   11.3%

     C)   16.8%

     D)   17.5%

     E)   20.1%

Explanation / Answer

The answer is:

D)   17.5%

Work:

Weight 1 = 1.25

Return 1 = 15%

Weight 2 = -.25

Return 2 = 5%

Expected Return = (1.25)(15%) + (-.25)(5%)

Expected Return = 18.75% - 1.25% = 17.5%

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