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Suppose the risk free rate is 4
Suppose the risk free rate is 4.4 percent and the market portfolio has an expected return of 10.9 percent. The market portfolio has a variance of .0391. Portfolio Z has a correlation coefficient with the market of .31 and a variance of .3407. According to the capital asset pricing model, what is the expected return on Portfolio Z?
Expert Solution
Computation of the expected return on portfolio Z:-
Covariance between stock and market = Correlation * (Market variance^0.5) * (Stock variance^0.5)
= 0.31 * (0.0391^0.5) * (0.3407^0.5)
= 0.03578
Beta = Covariance between stock and market / Market variance
= 0.03578 / 0.3407
= 0.11
Expected return = Risk free rate + Beta * (Expected market return - Risk free rate)
= 4.4% + 0.11 * (10.9% - 4.4%)
= 4.4% + (0.11 * 6.5%)
= 4.4% + 0.68%
= 5.08%
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