A problem to be solved guys! Portfolio P includes stocks of UK firms in a variet

Question

A problem to be solved guys!

Portfolio P includes stocks of UK firms in a variety of different industries including, among others, Rio Tinto, Aviva and Unilever. The expected return of portfolio P is 5.00%. The expected market return is 4.0% and the variance of the returns of the market portfolio is 0.020. The risk free rate is equal to 1.7%. a. According to the CAPM, how much should the covariance of the returns of portfolio P with the returns of the market portfolio be? (Do not round intermediate calculations. Round your answer to 4 decimal places.) Covariance What is the beta of the portfolio? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Beta portfolio How would you characterize it in terms of risk? Aggressive portfolio Defensive portfolio If the realized return of the portfolio is 3.3%, would you invest in it if you believe in the validity of the CAPM? Yes No

Explanation / Answer

Answer:

b)-1: As per CAPM ; Expected return of the portfolio = Risk free rate+ Beta* Market risk premium

=> 5% = 1.7% + Beta * (4%-1.7%) =. Beta of the Portfolio = 1.43

a) Co variance = Beta * Variance of the market = 1.4348 * 0.02 = 0.0287

b-2 : As the beta is higher than the market - So it is an aggresive portfolio.

c : No, as the realized rate of return is lower than then expected rate of return.

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