You have $100,000 to invest in a stock portfolio. Your choices are Stock X with

Question

You have $100,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 15% and Stock Y with an expected return of 10%.

a) If your goal is to create a portfolio of 12%, how much money you should invest in Stock X and in Stock Y?                                                                                       

b) If risk free rate is 5% then calculate the Equity Risk Premium (ERP) for Stock X and Stock Y.                                                                                                      

c) If return on market portfolio is 8 percent, then calculate the Market Risk Premium for Stock X and Stock Y.                                                                                   

d) Calculate the beta of Stock X and Stock Y.                                                     

e) Now, that you have calculated the individual stock beta, calculate the portfolio beta. What you can interpret from the portfolio beta? Is your portfolio more risky or less risky compared to the market portfolio?                                                         

Please detailed answers. Consider 4 decimal places where applicable. When asked to

Explanation / Answer

a) W * .15 + (1 - W) * .10 = .12

.15W + .10 - .10W = .12

W = .02 / .05 = .40

Money to be invested in stock X = 100000 * 40% = 40000

Money to be invested in stock Y = 60000

b) ERP for X = .15 - .05 = 10%

ERP for Y = .10 - .05 = 5%

c) MRP = .08 - .05 = 3%

d) Beta of X = .10 / .03 = 3.33

Beta of Y = .05 / .03 = 1.67

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