E120

Homework 10
Not to be submitted

Note: the notion of of a portfolio is defined in the lecture notes.

1. Assume that CAPM holds, i.e. ri = r0 + i (rm r0 ), where i =

im
2 .
m

Your goal is to create a portfolio of stocks X, Y, and the risk-free asset. The beta of
the portfolio is P = 0.70. X has a beta of 1.5 and Y has a beta of 2.0. Expected
return of Y is 10% more than the expected return of X. Risk-free rate is 5%. What is
the expected return of this portfolio?
2. You own a portfolio equally invested in a risk-free asset and two stocks. If one of the
stocks has a beta of 1.38 and the total portfolio is equally as risky as the market (i.e.
P = 1), what is the beta for the other stock in your portfolio?
3. A stock has a beta of 1.35 and an expected return of 16%. A risk-free asset currently
earns 4.8%.
(a) What is the expected return on a portfolio that is equally invested in the two
assets?
(b) If a portfolio of the two assets has a beta of 0.95, what are the portfolio weights?
(c) If a portfolio of the two assets as an expected return of 8%, what is its beta?
(d) If a portfolio of the two assets has a beta of 2.70, what are the portfolio weights?
How do you interpret the weights for the two assets in this case? Explain.
4. Assume we have two stocks, A and B. Stock A has expected return 12% and stock B
has expected return 15%. The beta for stock A is 0.8 and the beta for B is 1.2. The
expected returns of both stocks lie on the SML line.
(a) What is the expected return of the market?
(b) What is the risk-free rate?
(c) What is the beta of a portfolio made of these two assets with equal weights?