Is it possible to construct a portfolio of stocks that has an expected return equal to the riskfree
rate?
Yes -- if the portfolio is large enough and consists of stocks with a history of being profitable with good management. A diversified portfolio will include stocks of various size and in various industries. Twenty well-chosen stocks will probably have a higher return rate than riskfree investments.
Ambler, Inc. will pay $4.00 per share dividend next year. The company pledges to increases its dividend by 4% per year indefinitely. If you require a 12% return on you investment, how much will you pay for the company's stock today?
Suppose Bulldog, Inc. just paid a dividend of $2.00 per share. The company expects to increase its dividend by 2% per year indefinitely. If the market requires a return of 10% on assets of this risk, how much the stock should be selling for?
Yes, it is possible to construct a portfolio of stocks that has an expected return equal to the risk-free rate. To understand how, let's first define what the risk-free rate is.
The risk-free rate refers to the return an investor can expect to earn from an investment that carries no risk of default. It is often associated with government securities such as Treasury bonds or bills.
To construct a portfolio with an expected return equal to the risk-free rate, you would need to consider the principles of diversification. Diversification involves spreading investments across different asset classes, industries, and regions to reduce risk.
Here's a step-by-step process to construct such a portfolio:
1. Determine the risk-free rate: Check the current risk-free rate in the market. This rate can be found by looking at the yields of government securities like Treasury bonds or bills.
2. Research and select stocks: Conduct thorough research on different stocks to identify potential investments. Look for stocks with stable returns and low volatility.
3. Calculate the expected returns: Determine the expected returns of each stock by analyzing historical data, financial statements, industry trends, and other relevant factors.
4. Determine the portfolio weights: Assign weights to each stock in your portfolio based on their expected returns and desired level of risk. To achieve an expected return equal to the risk-free rate, you may need to adjust the weights accordingly.
5. Monitor and rebalance: Regularly monitor the performance of your portfolio and make necessary adjustments if any stock's performance deviates significantly from expectations. Rebalance the portfolio periodically to maintain the desired asset allocation and risk-return profile.
Note that constructing a portfolio with an expected return equal to the risk-free rate may be challenging in practice, as stocks inherently carry higher risk compared to risk-free assets. However, by carefully selecting stocks and diversifying your investments, you can aim to achieve a portfolio with a similar expected return.