An investor was expecting an 18% return on his portfolio with Beta of 1.25 before the market risk premium increased from 8% to 10%.Based on this change, what return will now be expected on the portfolio?

Question

Quizplus · Accepted Answer

The expected return on the portfolio can be calculated using the Capital Asset Pricing Model (CAPM), which is given by the formula: Expected Return = Risk-Free Rate + (Beta * Market Risk Premium). Assuming the risk-free rate remains constant, the increase in the market risk premium from 8% to 10% would lead to an increase in the expected return. Originally, with an 18% expected return and a market risk premium of 8%, the increase to a 10% market risk premium, keeping the Beta at 1.25, means the expected return would increase by 1.25 * (10% - 8%) = 2.5%. Adding this to the original 18% gives an expected return of 20.5%.

An Investor Was Expecting an 18% Return on His Portfolio