You own $14,000 of Diner's Corp. stock that has a beta of 2.1. You also own $14,000 of Comm Corp. (beta = 1.3) and $12,000 of Airlines Corp. (beta = 0.6). Assume that the market return will be 15 percent and the risk-free rate is 6.5 percent. What is the total risk premium of the portfolio?
A) 11.645 percent
B) 20.55 percent
C) 23.905 percent
D) 38.00 percent

Question

Quizplus · Accepted Answer

The total risk premium of the portfolio is calculated using the formula for the expected return based on the Capital Asset Pricing Model (CAPM): Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). First, calculate the portfolio beta as a weighted average of the individual betas, then use it to find the risk premium, which is the difference between the expected return of the portfolio and the risk-free rate.Portfolio Beta = (Beta of Diner's Corp * Proportion of Diner's Corp) + (Beta of Comm Corp * Proportion of Comm Corp) + (Beta of Airlines Corp * Proportion of Airlines Corp)= (2.1 * $14,000 + 1.3 * $14,000 + 0.6 * $12,000) / ($14,000 + $14,000 + $12,000)= (29,400 + 18,200 + 7,200) / 40,000= 54,800 / 40,000= 1.37Expected Return of Portfolio = 6.5% + 1.37 * (15% - 6.5%)= 6.5% + 1.37 * 8.5%= 6.5% + 11.645%= 18.145%The risk premium of the portfolio is the expected return minus the risk-free rate, which is 18.145% - 6.5% = 11.645%.

You Own $14,000 of Diner's Corp