Stock J has a beta of 1.35 and an expected return of 17 percent, while
QUESTION
Stock J has a beta of 1.35 and an expected return of 17 percent, while stock K has a beta of .80 and an expected return of 10 percent. You want a portfolio with the same risk as the market. How much you invest in each stock? What is the expected return of your portfolio?
Beta is also a measure of risk. Beta of market is always 1.0. To create a portfolio with same risk as the market the portfolio should have a beta of 1.0. Let the investment in Stock J is X and in Stock K is (1 X) Beta of Portfolio = 1.35 * X + 0.80 * (1 X) = 1.0 Or,0.55 X + 0.80 = 1.0 Or, X = 0.2 / 0.55 = 0.3636 or 36.36%¦
, the investment in Stock J = 36.36% and in Stock K = (100% 36.36%) = 63.64% Expected return of Portfolio = Weight of J* Return on J + Weight of K * Return on K Or, Expected Return = 0.3636 * 17% + 0.6364 * 10% = 12.545%
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