Given the following information, answer the questions below:

Risk free rate:  5%
Market rate:    10%

Stock			Expected Return		Beta(source Quicken.com)

IBM				13%			1.48
GE				10			1.07
GM				8			1.20
MMM				7			0.49
a.	Create an equal weighted portfolio and determine its expected
return, risk and required return.
b.	Is the portfolio a wise investment?  Explain.
c.	Graph the SML and include an illustration of your answer to part b.
d.	What is the impact on your recommendation if the market risk premium rose to 7%?

a.  An equal weight portfolio will have equal amounts of each of the
four securities.  Therefore, the portfolio's expected return and beta
can be calculated by simply determining the average of those measures.

Expected return: (13+10+8+7)/4 = 9.5%
Beta: (1.48 +1.07 +1.2 +0.49)/4 = 1.06

We use the Capital Asset Pricing Model to calculate the portfolio's
required rate of return.

r = beta (rm -rf) +rf = 1.06 (10-5) + 5 = 10.3%

b.  The portfolio would not be a wise investment because its expected
rate of return is less than the required rate of return necessary to
offset its risk relative to simply holding the market portfolio with
sufficient leverage through borrowing to achieve a beta of 1.06.

c.  "Capital Asset Pricing Model (CAPM)" Prentice-Hall, Inc. (2000)
http://www.prenhall.com/divisions/bp/app/cfldemo/RR/CAPM.html
demonstrates how to graph the Security Market Line (SML).

d.  (rm -rf) is the market risk premium.  If it rises to 7%, then the
portfolio's required rate of return is 1.06 (7) + 5 = 12.42%.  The
portfolio's expected rate of return is even farther away from the
required rate of return, so it is even more unattractive in this
scenario than it was before.  Investing in the portfolio does not
adequately compensate the investor for the additional risk associated
with a beta of 1.06 relative to that of a leveraged investment in the
market portfolio.

Sincerely,

Wonko

Thanks for the help, you saved my life. The link was awesome.