Supose you invested 70% of your wealth in the market portfolio and the remainder of your wealth in the shares in the law firm. What would be the beta of your portfolio?

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Complete Question

We Do Bankruptcies is a law firm that specializes in providing advice to firms in financial distress. It prospers in recessions when other firms are struggling. Consequently, its beta is negative, −0.3.

a. If the interest rate on Treasury bills is 4% and the expected return on the market portfolio is 14%, what is the expected return on the shares of the law firm according to the CAPM? (Enter your answer as a whole percent.)

b. Supose you invested 70% of your wealth in the market portfolio and the remainder of your wealth in the shares in the law firm. What would be the beta of your portfolio

a. Expected return on the share = 1%

b. Portfolio Investment = 61%

Explanation:

a.

Expected return on the share is calculated as:

r = rf+ β(rm - rf)

Given

rf = Interest rate on Treasury bills = 4%

β = Beta = -0.3

rm = Expected return on the market portfolio = 14%

r = 4% -0.3(14% - 4%)

r = 4% - 0.3(10%)

r = 0.04 - 0.3(0.10)

r = 0.04 - 0.03

r = 0.01

r = 1%

b.

Portfolio Investment is calculated as;

(I * r) + ((1 - I) * (β))

Where I = Investment = 70%

r = 1

β = Beta = -0.3

Investment = (70% * 1%) + ((1 - 70%) * (-0.3))

Investment = (70% * 1) - (30% * 0.3)

Investment = (0.7 * 1) - (0.3 * 0.3)

Investment = 0.61

Investment = 61%