CFA Level I · CFA Level I Exam · Portfolio Risk and Return: Part II
A portfolio has 40% invested in the risk-free asset (return 2%) and 60% in a stock with beta 1.5. The market risk premium is 5%. The portfolio's beta and expected return under CAPM are closest to:
The portfolio beta is 0.9 and its expected return is 6.5%. Beta is the weighted average of 0 for the risk-free asset and 1.5 for the stock, giving 0.9. Adding 0.9 times the 5% premium to the 2% risk-free rate gives 6.5%.
- Abeta 0.6; expected return 3.0%
- Bbeta 0.9; expected return 6.5%Correct
- Cbeta 1.5; expected return 9.5%
Explanation
Portfolio beta = 0.4×0 + 0.6×1.5 = 0.9. Expected return = 2% + 0.9×5% = 6.5%. Checking by weights: stock return = 2% + 1.5×5% = 9.5%; 0.4×2% + 0.6×9.5% = 0.8% + 5.7% = 6.5%. Beta 1.5 ignores the risk-free weight.
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