What is a Portfolio?

What is the required annual return of this portfolio?

• Quippy Inc (“Quippy”) and Whippy Inc (“Whippy”) have common shares listed on the New York Exchange. Assume that the S&P 500 Index represents the market portfolio. An equal-weighted portfolio of Quippy’s shares and a risk-free asset has an annual variance of 0.04. An equal-weighted portfolio of the S&P 500 Index and a risk-free asset has an annual variance of 0.01. An equal-weighted portfolio of Quippy’s shares and the S&P 500 Index has an annual variance of 0.08. The risk-free asset has an expected annual return of 3%, and the S&P 500 Index has an expected annual return of 7%. Suppose you want to put together an equal-weighted portfolio of Quippy’s and Whippy’s shares. Whippy’s shares have the same beta as the S&P 500 Index. What is the required annual return of this portfolio?

• Answer:

  CAPM says that if it has the same beta as the market then it ought to have the same expected return as the market. The portfolio has a beta of 1 (i.e., 1/2*1 + 1/2*1) so it is exxpected to have a return of 7%