Answer: The answer is provided below
Explanation:
The weights of assest in Rachel's portfolio: = amount in each stock ÷ sum of the amounts invested in all stocks.
Share Amount Weight
A. 13500. 0.33
B. 7600. 0.18
C. 14700. 0.36
D. 5500. 0.13
Total 41300
Note that weight = amount/total
Geometric average return of a portfolio:
((1+R1)×(1+R2)×(1+R3)....×(1+Rn))^(1/n) - 1
where,
R1= return of period 1
Rn= return in nth period
Hence, the geometric average return of Rachel's portfolio will be:
((1+9.7%)×(1+12.4%)×(1-5.5%)×(1+17.2%))^(1/4) - 1
= 8.10 % (approximately) per year.
Using the nominal rate of return which includes inflation:
CAPM: Required return will be:
= Risk free return + (Risk premium × Beta)
13.6 = Risk free return + (4.8 × 1.5)
13.6 = Risk free return + 7.2
Risk free return = 13.6 - 7.2
= 6.4% which is not inflation adjusted)
The inflation adjusted rate of return will be:
= (1+return)/(1+inflation rate))-1
= ((1+13.6%)/(1+2.7%))-1
= 10.61%
Using CAPM:
10.61= Risk free return + (4.8 × 1.5)
10.61 = Risk free return + 7.2
Risk free return = 10.61 - 7.2
Risk free return = 3.41% (at real rates)
In practice, the use of inflation adjusted return i.e the real rate of return which is 10.61% is better as it puts forth a long term perspective on how a stock is performing.
