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Unformatted text preview: 6. Given $1000, describe how to construct a portfolio with a beta of 2 comprised of CDE stock and the riskfree asset. What is the expected annual return for this portfolio? Solution: 1. Risk premium = 1.5 x 8 = 12%. Expected return = 5 + (1.5 x 8) = 17%. 2. 5/12 + 1.5 x (2  5/12)= 3.21% 3. CDEs idiosyncratic return was 3  (3.21) = .21%. 4. Systematic risk = 1.5 x 1.5 = 2.25. Idiosyncratic risk = 0.9. Total risk = sqrt(2 . 25 2 + 0 . 9 2 ) = 2.42%. 5. Between 17/12  (2 x 2.42) = 3.42% and 17/12 + (2 x 2.42) = 6.26%. 6. 2 = w * 1 . 5+(1w ) * 0, solve for w. You should get w=4/3. So, borrow $333.33 at the riskfree rate and put $1333.33 in CDE. The expected return for this portfolio should be 5+2*8 = 21%....
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 Fall '07
 DONCHEZ,RO
 Corporate Finance

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