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The expected rates of return on portfolios A and B are 11% and 14%, respectively. The beta of A is 0.8 and the beta of B is 1.5. The T-bill rate is currently 6%, while the expected rate of return on S&P500 index is 12%. The standard deviation of portfolio A is 10% annually, while that of B is 31%, and that of the index is 20%. If you currently hold a market index portfolio, would you choose to add either of these portfolios to your holdings? Discuss your answer.

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Answer:

Portfolio B has a higher return but more volatile stocks. However it depends on how the individual can tolerate risks.

Explanation:

Expected return= free return + Beta (Expected rate of return – risk free rate)

Portfolio A

6%+ +.8*6%

= 6%+4.8%= 10.8%

Portfolio B

6%+1.5(6%)

6%+9%= 15%

It depends on different factors. Portfolio B has a higher return but more volatile stocks. However it depends on how the individual can tolerate risks.

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