Consider an investment portfolio that consists of three different stocks, with the amount invested in each asset shown
below. Assume the risk-free rate is 2.5% and the market risk premium is 6%. Use this information to answer the
Stock Weights Betas
Chesapeake Energy 25% 0.8
Sodastream 50% 1.3
Pentair 25% 1.0
a) Compute the expected return for each stock using the CAPM and assuming that the stocks are all fairly priced.
b) Compute the portfolio beta and the expected return on the portfolio.
c) Now assume that the portfolio only includes 50% invested in Pentair and 50% invested in Sodastream (i.e., a twoasset
portfolio). The yearly-return standard deviation of Pentair is 48% and the yearly-return standard deviation of
Sodastream is 60%. The correlation coefficent between Pentair’s returns and Sodastream’s returns is 0.3 What is the
expected yearly-return standard deviation for this portfolio?
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