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

Exercise (Chapter 8)

Risk and Return - CAPM

No Question Reference Answer

FM book, 13th
Edition

1 Penny Francis inherited a $200,000

portfolio of investments from her 8-5
grandparents when se turned 21 years of
age. The portfolio is comprised 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?

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

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 8-17
expected market portfolio 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 8-18

expected market portfolio return is 10.5%
and the risk free rate is 3.5%, what is the
appropriate expected return of
Breckenridge (using the CAPM)?

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

4 You are putting together a portfolio made

up of four different stocks. 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?

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