Sarah owns a portfolio of stocks that have a market value of Rs. 50,000, and an estimated CAPM beta of 0.90. (a) If the market risk premium is 9%, and the risk-free rate is 6%, what is the expected equilibrium return on this portfolio? (b) If Sarah decides to sell one of her holdings that has a market value of Rs. 10,000 and a beta of 0.75, and invest the proceeds in another stock having a beta of 1.3, what is the new equilibrium expected return on her portfolio?
Answers
Therefore, with an initial portfolio value of Rs. 50,000, Sarah can expect an equilibrium return of R.s 50,000*(14.1%) = R.s 7,050
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Answer:
(a) Ans: CAPM : Capital Asset Pricing Model
Explanation:
a.) Ans:
CAPM Formulae -E(ri)=rf +βi[E(rm)- rf],Where[E(rm)- rf]= Expected Risk Premium,rf =6%;βi=0.90 and [E(rm)- rf] = 9%HenceExpected ReturnE(ri)=6% + 0.9 [9%] =14.1%
(or)
CAPM =Capital Asset Pricing Model.
Since the market risk premium is already given as 9% and the CAPM beta of .90, then it follows that the expected equilibrium return =.90 x 9% =0.081 + Risk-free rate of 6% =14.1%.
(b). Ans:
The Beta of portfolio Formula:
βp= (wx*βx)+(Wy*βy)
Weight of the stock sold (Stock X),wx= 10,000 /50,0000 =0.2
Weight of the stock held (Stock Y),Wy= (50,000- 10,000) /50,0000 = 0.8
There fore
Wx = 0.2
βx = 0.75
Wy = 0.8
βy = 1.3
= ((0.2)x(0.75))+((0.8)x(1.3))
= (0.14)+(1.04)
= 1.44
Therefore the Beta of the portfolio is
βp= 1.44