b) Suppose that the risky premium on the market portfolio is estimated at 8% wit

Question

b)            Suppose that the risky premium on the market portfolio is estimated at 8% with a standard deviation of 22%. What is the risk premium of a portfolio invested 25% in CEMENCO and 75% in Monrovia Breweries, if they have Betas of 1.1 and 1.25 respectively?

c)            Suppose the two factor portfolios, here called portfolio 1 and 2, have Expected Returns E (r1) = 10% and E(r2) = 12%. Suppose further that the risk-free-rate is 4%. The risk premium on the first factor portfolio is therefore 6%, while that on the second factor portfolio is 8%. Now consider an arbitrary well-diversified Portfolio (P), with Beta on the first factor, BP1 =.2 and the second factor BP2 = 1.4. Find the fair rate of return on the security.

d)            What do most empirical studies suggest about the stock market?

Explanation / Answer

b)

=0.25*(1.1*8%)+0.75*(1.25*8%)

=9.7%

c)

=4%+0.2*6%+1.4*8%

=16.4%

d)

Most empirical studies suggest that there is unidirectional causality between the stock market development & economic growth with the direction from the stock market development to growth of the economy.

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