An investor is forming a portfolio by investing $50,000 in stock A that has a beta of 1.50, and $25,000 in stock B that has a beta of 0.90. The market risk premium is equal to 6% and Treasury bonds have a yield of 4%. What is the required rate of return on the investor's portfolio?

Portfolio r =  0.118 or 11.8%

Explanation:

The required rate of return of a portfolio is calculated by taking the weighted average of the required rates of return of each individual stock contained in the portfolio. The formula for the required rate of return of a portfolio is as follows,

Portfolio r = wA * rA  +  wB * rB + ...  +  wN * rN

Where,

To calculate the required rate of return of the portfolio, we first need to calculate the required rate of return of each stock. Using the CAPM, we can calculate the required rate of return on a stock. This is the minimum return required by the investors to invest in a stock based on its systematic risk, the market's risk premium and the risk free rate.

The formula for required rate of return under CAPM is,

r = rRF + Beta * rpM

Where,

r of A = 0.04 + 1.5 * 0.06 = 0.13 or 13%

r of B = 0.04 + 0.9 * 0.06 = 0.094 or9.4%

Total investment in the portfolio = 50000 + 25000 = 75000

Portfolio r = 50000/75000 * 0.13  +  25000/75000 * 0.094  =  0.118 or 11.8%

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