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Consider two potential portfolios, A and B. Based on current dividend yields and your estimates of expected capital gains, you expect rates of return on portfolio A is 12% and on portfolio B is 16%. The standard deviation of portfolio A is 12% annually, and the standard deviation of portfolio B is 31%.
You have determined that the Beta of portfolio A is 0.7, while the Beta of portfolio B is 1.4. The current risk-free (US Treasury) rate is 5.0%. Your estimate for the expected return of the S&P 500 market index is 13%. The standard deviation of the S&P 500 index is 18%.
Questions:
a. If you currently hold only the market index portfolio, would you choose to add either of these portfolios (eitherA or B) to your overall portfolio? Explain and show your work. (Hint: think about the CAPM).
b. IF instead you could invest ONLY in Treasuries and ONLY ONE of these portfolios, would you choose A or B? Why?
You are a venture capitalist and have been approached by Cirrus Electronics, a private firm. The firm has no debt outstanding and does not have earnings.
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