Us I Parrino, Fundamentals of Corporate Finance, 3e FINANCIAL MANAGE Gradebook O

Question

Us I Parrino, Fundamentals of Corporate Finance, 3e FINANCIAL MANAGE Gradebook ORION oadable eTextbook ent Sample Test Problem 7.3 You have just invested in a portfolio of three stocks. The amount of money that you invested in each stock and its beta are summarized below. $224,000 336,000 560,000 1.50 0.69 1.35 g model (CAPM) to compute the expected rate of return for the portfolio. Assume that the expected rate of return on the market is 16 percent and that the risk-free rate is 8 percent. (Round beta answer to 3 decimal places, e.g. rate of return answer to 2 decimal places, e.g. 52.75%.) Beta of the portfolio By accessing this Question Assistance, you will learn while you earn points based on the Point Potential Policy set by your instructor Question Attempts: 0 of 3 used SAVE OR LATER SUBMIT ANSWER Earn Maximum Points available only if you answer this question correctly in two attempts or less.

Explanation / Answer

Solution: Beta of the portfolio 1.182 Expected rate of return 17.46% Working Notes: Beta of the portfolio Beta of a Portfolio = Weighted average risk of individual assets. B1 = 1.5 W1 = investment/ total investment = 224,000/(224,000 + 336,000 + 560,000 ) = 0.20 B2 = 0.69 W2 = investment/ total investment = 336,000/1,120,000 = 0.30 B3 = 1.35 W3 = investment/ total investment = 560,000/1,120,000 = 0.50 Beta of a Portfolio = Weighted average risk of individual assets. = B1 x W1 + B2 x W2 + B3 x W3 = 0.20 x 1.50 + 0.69 x 0.30 + 1.35 x 0.50 = 1.182 Expected rate of return E(R)=Rrf+(RmRrf) Rrf= 8% Rm = 16% Beta of portfolio B = 1.182 E(R)=Rrf+(RmRrf) = 8% + (16% - 8%) x 1.182 = 8% + 8% x 1.182 = 8% + 9.456 % = 17.456 % = 17.46% Please feel free to ask if anything about above solution in comment section of the question.

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