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30 November, 12:54

Suppose that borrowing is restricted so that the zero-beta version of the CAPM holds. The expected return on the market portfolio is 14%, and on the zero-beta portfolio it is 7%. What is the expected return on a portfolio with a beta of 0.5?

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  1. 30 November, 13:24
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    10.5%

    Explanation:

    In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below

    Expected rate of return = Risk-free rate of return + Beta * (Market rate of return - Risk-free rate of return)

    where,

    Risk free rate of return = 7%

    Market rate of return = 14%

    And, the beta is 0.5

    So the expected return is

    = 7% + 0.5 * (14% - 7%)

    = 7% + 0.5 * 7%

    = 7% + 3.5%

    = 10.5%
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