Assume you have created a 2-stock portfolio by investing $30,000 in stock X with a beta of 0.8, and $70,000 in stock Y with a beta of 1.2. Market risk premium is 8% and risk-free rate is 6%. The followings are the probability distributions of Stocks X and Y’s future returns: State of Economy Probability rx rY Recession 0.1 -10% -35% Below average 0.2 2% 0% Average 0.4 12% 20% Above average 0.2 20% 25% Boom 0.1 38% 45% Calculate the portfolio’s expected rate of return and the standard deviation of its future returns Calculate the required rate of return of your portfolio. Which stock in your portfolio is currently under-valued? Explain.
Assume you have created a 2-stock portfolio by investing $30,000 in stock X with a beta of 0.8, and $70,000 in stock Y with a beta of 1.2. Market risk premium is 8% and risk-free rate is 6%.
The followings are the probability distributions of Stocks X and Y’s future returns:
|
State of Economy Probability rx rY |
|
Recession 0.1 -10% -35% |
|
Below average 0.2 2% 0% |
|
Average 0.4 12% 20% |
|
Above average 0.2 20% 25% |
|
Boom 0.1 38% 45% |
- Calculate the portfolio’s expected
rate of return and the standard deviation of its future returns - Calculate the required rate of return of your portfolio.
- Which stock in your portfolio is currently under-valued? Explain.
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