Question 1. Abigail Grace has a $900,000 fully diversified portfolio. She subsequently inherits ABC Company common stock worth $100,000. Her financial advisor provided her with the following estimates:
Expected Monthly Returns Standard Deviation of Monthly Returns
Original Portfolio 0.67% 2.37%
ABC Company 1.25 2.95
The correlation coefficient of ABC stock returns with the original portfolio returns is 0.40. The inheritance changes Abigail's overall portfolio and she is deciding whether to keep the ABC stock. Assuming Abigail keeps the ABC stock, calculate:
a. the expected return of her new portfolio which includes the ABC stock.
b. covariance of ABC stock returns with the original portfolio returns.
c. the standard deviation of her new portfolio which includes the ABC stock.
Question 2. In previous problems using CAPM Ki=Rf + bi(Km-Rf),we were solving for expected rate of return. How can CAPM be used to calculate expected return, please explain and show calculations.
Karen Kay, a portfolio manager at Collins Asset Management, is using CAPM for making recommendations to her clients. Her research department has developed the following information:
Forecasted Return Standard Deviation Beta
Stock X 14% 36% .8
Stock Y 17 25 1.5
Market Index 14 15 1
Risk-Free rate:5
Calculate expected return for each stock.