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There are only three stocks in the economy. Stock A has 20 shares outstanding and a price per share of $10. Stock B has 15 shares outstanding and a price per share of $3. Stock C has 10 shares outstanding and a price per share of $5. I decide to invest $1000 in the T-bill and $5000 in a risky portfolio that can be formed out of these 3 stocks. If the CAPM is correct, how much money should I invest in Stock A?

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Answer:

Market value of stock A = 20 shares x $10 = $200

Market value of stock B = 15 shares x $3   = $45

Market value of stock C = 10 shares x $5   = $50

Total market value                                          $295

Amount to invest in stock A

= $200/$295 x $5,000

= $3,389.83

Explanation:

In this case, we will calculate the market value of each stock by multiplying the number of each stock by their corresponding market prices.

Thereafter, we will divide the market value of stock A by the total market value multiplied by amount available for investment ($5,000).

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