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    Investing in Market Based Portfolio

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    Based on current dividend yields and expected capital gains, the expected rates of return on portfolios A and B are 11% and 14%, respectively. The beta of A is 0.8, while that of B is 1.5. The T-bill rate is currently 6%, whereas the expected rate of return of the S&P 500 index is 12%. The standard deviation of portfolio A is 10% annually, that of B is 31%, and that of the S&P 500 index is 20%.

    a. If you currently hold a market-index portfolio, would you choose to add either of these portfolios to your holdings? Explain.

    b. If instead you could invest only in T-bills and one of these portfolios, which would you choose? Why?

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    Solution Preview

    a. Expected Return of Portfolio A = 11%
    Expected Return of Portfolio B = 14%
    Beta of Portfolio A = 0.8
    Beta of Portfolio B = 1.5
    Risk free rate = 6%
    Return on Market = 12%
    Standard deviation of portfolio A=10%
    Standard deviation of portfolio B=31%
    Standard deviation of market portfolio =20%

    Required return on Stock A using CAPM = Risk free rate + ...

    Solution Summary

    Details of investing in market based portfolio are implied.