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22 January, 08:49

An investor is forming a portfolio by investing $50,000 in stock A which has a beta of 1.50, and $25,000 in stock B which has a beta of 0.90. The return on the market is equal to 6 percent and Treasury bonds have a yield of 4 percent. What is the required rate of return on the investor's portfolio?

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  1. 22 January, 09:01
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    6.6%

    Explanation:

    For computing the required rate of return, first we have to determine the weights of stock A and stock B and portfolio beta which is shown below:

    Stock A weighatge = Invested amount : total amount

    = $50,000 : $75,000

    = 0.66667

    Stock B weighatge = Invested amount : total amount

    = $25,000 : $75,000

    = 0.333333

    Total amount = $50,000 + $25,000 = $75,000

    Now multiply the weighatge into its beta

    = Stock A weighatge * stock A beta + Stock B weighatge * stock B beta

    = 0.66667 * 1.50 + 0.333333 * 0.90

    = 1 + 0.30

    = 1.30

    Now the required rate of return would be

    Expected rate of return = Risk-free rate of return + Beta * (Market rate of return - Risk-free rate of return)

    = 4% + 1.30 * (6% - 4%)

    = 4% + 1.30 * 2%

    = 4% + 2.6%

    = 6.6%
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