Question
Stock A has a correlation with the market of 0.40 and a standard deviation of 20%, and stock B has a correlation with the market
Stock A has a correlation with the market of 0.40 and a standard deviation of 20%, and stock B has a correlation with the market of 0.75 and a standard deviation of 25%. The market has an expected return of 12%, a standard deviation of 18%, and the risk-free rate is 3%. (a) Calculate the beta and expected return for each stock according to the CAPM. (b) Using the expected returns calculated in the prior question, calculate the expected return of a portfolio consisting of 20% stock A and 80% stock B. (c) Calculate the beta of the portfolio (again, 20% stock A and 80% stock B). (d) Using the portfolio beta and the SML, calculate the expected rate of return of the portfolio according to the CAPM, and compare this to your answer to part (b)
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