MBSA 1453/1463 Financial Management and Corporate Governance/Strategic Financial Management

Exercise (Chapter 8)

Risk and Return - CAPM

No Question Reference
FM book, 13th Edition

1 Penny Francis inherited a $200,000 portfolio of investments from her

grandparents when se turned 21 years of age. The portfolio is comprised 8-5
of treasury bills and stock in Ford (F) and Harley Davidson (HOG)

Expected $ Value
return
Treasury 4.5% 80,000
bills
Ford (F) 8% 60,000
Harley 12% 60,000
Davidson
(HOG)

a) Based on the current portfolio composition and the expected

rates of return, what is the expected rate of return for Penny’s
portfolio?
b) If penny wants to increase her expected portfolio rate of return,
she can increase the allocation weight of the portfolio she has
invested in stock (Ford and Harley Davidson) and decrease her
holdings of Treasury bills. If penny moves all her money out of
treasury bills and splits it evenly between the two stocks, what
will be her expected rate of return?
c) If penny does move money out of treasury bills and into the two
stocks, she will reap a higher expected portfolio return, so why
would anyone want to hold treasury bills in their portfolio?
2 Breckenridge Inc. has a beta of 0.85. If the expected market portfolio 8-17
return is 10.5% and the risk free rate is 3.5%, what is the appropriate
expected return of Breckenridge (using the CAPM)?

3 CSB Inc. has a beta of 0.765. If the expected market portfolio return is 8-18
10.5% and the risk free rate is 3.5%, what is the appropriate expected
return of Breckenridge (using the CAPM)?

4 You are putting together a portfolio made up of four different stocks. 8-23

Prepared by: Assoc Prof Dr Maizaitulaidawati Md Husin Page 1

MBSA 1453/1463 Financial Management and Corporate Governance/Strategic Financial Management

However, you’re considering to possible weightings:

Portfolio weightings
Asset Beta First Second
portfolio portfolio
A 2.5 10% 40%
B 1.0 10% 40%
C 0.5 40% 10%
D -1.5 40% 10%

a) What is. The beta on each portfolio?

b) Which portfolio is riskier?
c) If the risk free rate of interest is 4% and the market risk premium
is 5%, what rate of return do you expect to earn from each of the
portfolios?

Prepared by: Assoc Prof Dr Maizaitulaidawati Md Husin Page 2