Consider a portfolio consisting of the following three stocks: The volatility of the market portfolio is 10% and it has an expected return of 8%. The risk-free rate is 3%. (1)Compute the beta and expected return of each stock. (2)Using your answer from part a, calculate the expected return of the portfolio. (3)What is the beta of the portfolio? (4)Using your answer from part c, calculate the expected return of the portfolio and verify that it matches your answer to part b.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Consider a portfolio consisting of the following three stocks:
The volatility of the market portfolio is 10% and it has an expected return of 8%. The risk-free rate is 3%.
(1)Compute the beta and expected return of each stock.
(2)Using your answer from part a, calculate the expected return of the portfolio.
(3)What is the beta of the portfolio?
(4)Using your answer from part c, calculate the expected return of the portfolio and verify that it matches your answer to part b.
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