I need expert advice on the price of risk Thanks so much 7. The price of risk Aa

Question

I need expert advice on the price of risk

Thanks so much

7. The price of risk Aa Aa An investor is evaluating two Investments: a risk-free asset and the common stock of Schallhelm Inc. The investor is going to construct a portfolio consisting of the rlsk-free asset and Schallhelm's stock. The following table shows the various portfolio expected return and beta combinations that could be achieved by his portfolio Percentage of Portfolio in Schallheim 096 25% 50% Portfolio Expected Return 6.00% 7.50% 9.00% 10.50% 12.00% 13.50% Portfolico Beta 0.0 0.25 0.50 0.75 1.00 1.25 75 100% 125% What is the reward-to-risk ratio for Schallhelm's stock? O 8.0% 5.0% O 9.00% 9.0% 7.0% 6.0% O Merton Corp, has a hlgher beta than Schallheim Inc. Both stocks trade In the same market. Which of the following most accurately describes Merton's reward-to-risk ratio? Assume the market is efficlent. O Merton's reward-to-risk ratlo is higher than Schallheim's ratio Merton's reward-to-risk ratlo is the same as Schallheim's ratio O Merton's reward-to-risk ratlo is lower than Schallheim's ratio

Explanation / Answer

Expected portfolio return = (w1)*R1+(1-W1)*Rf

Where, W1 is weight of security in portfolio

for, 0% of Schallheim Stock in portfolio

Expectedd return is 6.00%

=> 0.06=W1*0+(1-W1)*Rf

=> 0.06=Rf

For, 25% of Schallheim Stock in portfolio

=>7.5%=(25%)*(R1)+(75%)*Rf

=> 0.075=(0.25)*(R1)+(0.75)*(0.06)

=> 0.075=(0.25)*R1+0.045

=> 0.075-0.045=(0.25)*R1

=> 0.03=(0.25)*R1

=> R1= 0.12~12%

Bp=(W1)*Bs+(1-W1)Bf

Bp=(w1)*Bs since, Beta for a risk free asset is zero

for W1=0.25

Bp=0.25

B1=1

now, reward-to-risk of a securityis

=(Expected return of security-Rf)/Beta=(0.12-0.06)/1

=0.06~6.00%

Reward-to-risk of Schallheim is 6.00%.

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