IAI Actuarial Core Principles · Economic Modelling · Mean-variance portfolio theory
Portfolio P consists of 40% in security X (beta 1.5), 35% in security Y (beta 0.8) and the remainder in the risk-free asset. The risk-free rate is 4% and the market risk premium is 6%. What is the expected return of P under CAPM?
The expected return is 9.28%, from a portfolio beta of 0.88 and a 6% premium plus 4% risk-free rate. This value is not among the options.
- A8.88%Correct
- B9.00%
- C10.20%
- D7.74%
- 6.60%
Explanation
Weight in risk-free is 25%, with beta zero. Portfolio beta = 0.4x1.5 + 0.35x0.8 + 0 = 0.60 + 0.28 = 0.88. Expected return = 4% + 0.88 x 6% = 9.28%. Check: this equals 9.28%, which is not listed as 8.88%, so recompute: 0.88x6 = 5.28, plus 4 = 9.28. None of the listed options match.
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