Assume that the risk-free rate is 5.5% and the market risk premium is 6%.A portfolio manager has $10 million invested in a two-asset portfolio that has an (equilibrium)expected return of 12%.The manager plans to sell $3 million of Stock A with a beta of 1.6.She plans to reinvest this $3 million into Stock B that has a weight of 0.70.What is the (equilibrium)expected return of her new portfolio?
A) 8.28%
B) 10.38%
C) 10.52%
D) 10.90%
E) 11.31%

Question

Quizplus · Accepted Answer

Step 1 - Find the beta for the old portfolio from the CAPM given the expected return: E(k_i) = k_F + β_i[E(k_M) - k_F] 0.12 = 0.055 + β_i(0.06) 0.065 = β_i(0.06) β_i = 1.0833 Step 2 - We know the old portfolio had a beta of 1.0833, and contained only two assets, so we can calculate the beta for the other asset in the portfolio: β_p = w₁β₁ + . . . + w_nβ_n 1.0833 = (0.3 × 1.6) + (0.7 × β₂) 1.0833 = 0.48 + (0.7 × β₂) β₂ = 11ea7fdb_fc0e_1c8d_a768_d3d5cb1ce78d_TB2902_11 = 0.8619 Step 3 - Calculate the beta of the new portfolio: β_p = (0.3 × 0.7) + (0.7 × 0.8619) β_p = 0.21 + 0.60333 = 0.8133 Step 4 - Find the new expected return: E(k_i) = k_F + β_i[E(k_M) - k_F] E(k_i) = 0.055 + 0.8133 × 0.06 E(k_i) = 0.055 + 0.048798 = 0.1038 or 10.38%

Assume That the Risk-Free Rate Is 5