A stock portfolio consists of four stocks. Stock A represents 20% of the portfolio and has a return of 6%. Stock B represents 30% of the portfolio and has a return of 8%. Stock C represents 20% of the portfolio and has a return of 4%. Stock D represents the remaining 30% of the portfolio and has a negative return of 5%. What is the average return of the portfolio?
Show answer & explanation
Correct answer: A
Explanation
The correct answer is Option 1 i.e. 2.9%.
The average return is calculated as
Average return = (wA × rA) + (wB × rB) + (wC × rC) + (wD × rD)
where:
w represents the weight of each stock in the portfolio, r represents the return of each stock
From the given data,
Stock A: wA = 0.20, rA = 6% = 0.06
Stock B: wB = 0.30, rB = 8% = 0.08
Stock C: wC = 0.20, rC = 4% = 0.04
Stock D: wD = 0.30, rD = 5% = -0.05
Now we can substitute these values into the formula:
Average return = (0.20 × 0.06) + (0.30 × 0.08) + (0.20 × 0.04) + (0.30 × -0.05)
⇒ 0.012 + 0.024 + 0.008 - 0.015
⇒ 0.029
Converting the average return back to a percentage
Average return = 0.029 × 100 = 2.9%
Therefore, the average return of the portfolio is 2.9%