In this case, the portfolio?s expected returns are simply a weighted
average of the returns of each of the stocks. The assumptions here
may be as important as the answer.
The CAPM predicts:
Rc = rf + ßc(rM - rf)
Rc is the company's expected return on capital
rf is the risk-free return rate, usually a long-term U.S. Treasury bill rate
rM is the expected return on the entire market of all investments.
Most measures use a common broad index, most often the S&P500 over the
past 5 or 10 years
ßc is the company's Beta, based on its covariance with the market.
Our Rc numbers for each stock are:
Stock A (20%): 5% + 0.7 * 13% = 14.1%
Stock B (30%): 5% + 1.2 * 13% = 20.6%
Stock C (24%): 5% + 1.4 * 13% = 23.2%
Stock D (26%): 5% + 1.9 * 13% = 29.7%
The weighting of the portfolio should bring you the following returns:
.20 * 14.1% + .30 * 20.6% + .24 * 23.2% + .26 * 29.7% = 22.29%
The important assumption here is that your portfolio and that stocks
A, B, C, D don?t have a high correlation in returns among themselves.
In other words, you wouldn?t want them all in the same industry, like
Atmel, Intel, Texas Instruments and National Semiconductor.