You have the following information on 4 stocks held in a very well diversified p

Question

You have the following information on 4 stocks held in a very well diversified portfolio:

Stock Investment Beta
A $ 200,000 1.50
B 300,000 - 0.50
C 500,000 1.25
D $1,000,000 0.75

Given that the market's required rate of return is 14.00% and the risk-free rate is 3.00%, calculate the required rate of return for the that portfolio.


Note that CAPM is the only method used to calculate the required rate of return for this problem. Based on your understanding of the capital asset pricing model, provide a VERY WELL JUSTIFICATION for why CAPM is used here. Note that a justification that says “the provided information is only applicable to CAPM” or anything similar is not acceptable.

Explanation / Answer

CAPM is applicable here since we are holding a well-diversified portfolio therefore, our required return will be directly proportional to the market risk premium Average beta = [200000(1.5)+300000(-0.5)+500000(1.25)+1000000(0.75)]/2000000 Average beta = 0.7625 Required return = Risk free + Beta ( Market risk premium ) Required return = 3% + 0.7625 (14%-3%) = 11.3875%

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