Asked by Alexis Garland on May 10, 2024
Verified
Which one of the following statements is correct about a portfolio that is invested 30% in stock A, 40% in stock B, and 30% in stock C?
A) The expected return on the portfolio is equal to the summation of the returns on the individual securities within the portfolio divided by three.
B) The standard deviation of the portfolio is equal to the summation of the weights of each security multiplied by the standard deviation of each respective security.
C) The expected return on the portfolio is equal to the portfolio beta times the weighted average of the expected returns of each of the individual securities in the portfolio.
D) The standard deviation of the portfolio is equal to the square root of the summation of the individual security variances.
E) The expected return of the portfolio is equal to the risk free rate of return plus a risk premium based on a weighted average of the betas of the individual securities and the market risk premium.
Portfolio Beta
A measure of the volatility, or systematic risk, of a portfolio in comparison to the market as a whole, indicating how much the investment’s value is expected to fluctuate.
Expected Return
The weighted average of all possible returns for a given investment, where the weights are the probabilities of each outcome, representing an anticipation of gains on an asset.
Market Risk Premium
The additional return over the risk-free rate that investors require to compensate them for the extra risk of investing in the stock market.
- Determine and explain the projected return for assets and portfolios in varying economic scenarios.
- Recognize the pivotal importance of portfolio weights in shaping the risk and return characteristics of a portfolio.
Verified Answer
MN
mehdi nickoueiMay 12, 2024
Final Answer :
E
Explanation :
The expected return of a portfolio is indeed calculated by considering the risk-free rate of return plus a risk premium, which is determined by the weighted average of the betas of the individual securities in the portfolio and the market risk premium. This aligns with the Capital Asset Pricing Model (CAPM) approach to estimating expected returns, taking into account the risk-free rate, the securities' systematic risk (beta), and the market risk premium.
Learning Objectives
- Determine and explain the projected return for assets and portfolios in varying economic scenarios.
- Recognize the pivotal importance of portfolio weights in shaping the risk and return characteristics of a portfolio.