You are an investment fund manager who can allocate funds between two stocks or form a portfolio of these two stocks. Stock A has a Beta of 1.65 and Stock B has a Beta of 0.55. The market portfolio is expected to return 11.8% and the T-bill rate is 3.2%.
a) What is the expected return on each stock?
b) What is the expected return on a portfolio that consists of $37,500 invested in asset A and $62,500 invested in asset B?
c) What is the portfolio Beta of an asset with 30% of the funds invested in asset A and 70% invested in asset B?
d) A client of yours wants a portfolio that has an expected return of 9.5%. How much must be invested in asset A and how much in asset B to accomplish this?
e) Suppose that Stock A actually returns 15% and Stock B returns 9% what should be expect to happen to the prices and returns of Stock A and B? Which is underpriced and which one is overpriced?