Using CAPM: A stock has a beta of 1.13 and an expected return of 12.1 percent. A

Question

Using CAPM: A stock has a beta of 1.13 and an expected return of 12.1 percent. A risk-free asset currently earns 5 percent.

1. What is the expected return on a portfolio that is equally invested       in the two assets?

2. If a portfolio of the two assets has a beta of .50, what are the       portfolio weights?

3. If a portfolio of the two assets has an expected return of 10       percent, what is its beta?

9. If a portfolio of the two assets has a beta of 2.26, what are the       portfolio weights? How do you interpret the weights for the two assets in       this case? Explain.

Explanation / Answer

1. expected return on a portfolio that is equally invested in the two assets = (12.1%+5%)/2 = 8.55%

2. 0.5= 1.13*w + 0*(1-w)

w= 44.25%

weight of stock = 44.25%

weight of risk fre asset = 55.75%

3. let the weight be w

10% = 12.1%*w + 5%*(1-w)

w= 70.42%

beta = 1.13*70.42% = 0.80

9.2.26= 1.13*w + 0*(1-w)

w= 200%

weight of stock = 200%

weight of risk fre asset = -100%

A negative portfolio weight means that you short sell the stock. If you are not familiar with short selling, it means you borrow a stock today and sell it

It means you borrow from risk free asset to invest in the stock

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