Portfolio change of required return calculaor

CFA Level I
#1

Practice Problem, please assist on how to arrive to the answer

STOCK ALLOCATION BETA DEVIATION

AAA 35% 0.90 53.00%

BBB 20% 1.50 57.00%

CCC 15% 1.20 60.00%

DDD 30% 0.50 64.00%

Portfolio Manager Jones calculated above portfolio beta to be 0.945 and expected return as 13.09 %

Jones plans to replace AAA with the same amount of additional DDD. Risk free rate is 6% and Market Risk Premium is 7.50%

If Jones proceeds with his plans, assuming market equilibrium, how many percentage points will the portfolio’s required return change: ____________

#2

Revise the new beta using the new weights, then calculate using the CAPM.

I don’t think deviations are needed here.

#3

Deviation is not needed, so revise the new rate and use CAPM, that will give you the solution.

#4

difference in return between DDD and AAA = (0.5 - 0.9) * 7.5 = -3%

now AAA is being replaced by same amount of DDD

so diff in return = 35% * -3% = -1.05%

#5

Caculate CAPM expected return of each holding:

E[R_AAA_] = 0.06 + 0.9*0.075 = 0.1275

E[R_BBB_] = 0.06 + 1.5*0.075 = 0.1725

E[R_CCC_] = 0.06 + 1.2*0.075 = 0.15

E[R_DDD_] = 0.06 + 0.5*0.075 = 0.0975

Expected return based on old weights = .1309

Calculate expected portfolio return based on new weights:

AAA = 0%

BBB = 20%

CCC = 15%

DDD = 65%

Expected return based on new weights = (0.2 * 0.1725) + (0.15 * 0.15) + (0.65 * 0.0975) = .120375

.1309 - .120375 = .010525 or 1.0525% difference in return

#6

Thank You