The distributions of rates of return for stocks of IBM and INTEL are given below:
State of Economy…...Probability of State Occurring….... IBM …. INTEL
Boom …………….……...……0.30……………...…..…....….........30%..........20%
Normal………………………….0.50………………….…......……..10%...........8%
Recession…………..………....0.20………………..…..…....…… -8%...........6%
The expected return for IBM = 12.40%........SD for IBM = 0.0179........ The coefficient of variation for IBM = 13.38%
The expected return for INTEL = 11.20%...... SD for INTEL = 0.003376.......... The coefficient of variation for INTEL = 5.81%
Please answer the questions below and show all steps.
An investor wants to invest 50% of his money in IBM stock with the beta of 1.2 and 50% in Intel stock with the beta of 0.80. The risk-free rate is 6% and the market expected return is 12%. For IBM and INTEL expected returns, use the ones provided above.
a) What is the expected return of a portfolio of 50% in IBM and 50% Intel?
b) What is the beta of this portfolio of 50%-50% in IBM and Intel?
c) Given the portfolio of beta you calculated above, what is the required rate of return on this portfolio? (hint: use SML formula)
d) Is this portfolio in equilibrium? If not, is it overvalued or undervalued? Would you invest in this portfolio or short-sell this portfolio?
Please show all steps and calculations.