Wize University Introduction to Finance Textbook > CAPM
Risk-Free Borrowing
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Risk-Free Borrowing
Risk-free borrowing (investing on margin) means that an investor borrows money at a risk-free rate in order to invest in some other risky asset.
Investors take advantage of margins offered by their banks or brokers in order to increase how much they can invest in stock to maximize their gains, however, since the amount invested is borrowed then there is also the risk of greater losses.
Computing Portfolio Expected Return and Standard Deviation with 2nd Asset is Risk-Free
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Example: Risk-Free Borrowing
You have $8,000 to invest and are considering investing in Stock X which has an expected return of 12% and a standard deviation of 9%. The stock is currently trading at $50 per share but you are so sure in the stock that you use your margin account in order to buy 200 shares, meaning that you will borrow what you are missing at the risk free rate to make this trade. The risk free rate is 3%.
- What is the expected return?
- What is the standard deviation?
Practice: Risk-Free Borrowing
You have $10,000 to invest and decide to put it all in Apple's stock which is trading at $177.57. You buy 80 shares by borrowing the amount you're missing from your broker at a risk-free rate of 4%. Apple has an expected return of 20% and a standard deviation of 15%.
What is the expected return of this portfolio?
| The expected return is | % |