You are a small money manager managing $9,000,000 in assets. Your investment por
ID: 2637422 • Letter: Y
Question
You are a small money manager managing $9,000,000 in assets. Your investment portfolio consists of 10% T-bills (with an estimated beta = 0), 15% bonds (with an estimated beta = 0.70), 35% mid-cap stocks (with an estimated beta = 1.00), and 40% growth stocks (with an estimated beta = 1.40).
The risk-free rate, rRF, is 3.5%. The market risk premium, (rM - rRF), is 5.0%. What is the required rate of return on your investment portfolio? (10 points)
If you switch $450,000 out of T-bills and invest $300,000 of it in growth stocks and $150,000 of it in mid-cap stocks, what would be the required rate of return on your portfolio? (10 points
Explanation / Answer
Beta of the portfolio = 0 * 10% + 0.7 * 15% + 1 * 35% + 1.4 * 40% = 1.015
required rate of return = Rf + Market risk premium * Beta = 3.5% + 5.0% * 1.015 = 8.575%
Previos investment of the investor in Growing stocks = 9,000,000 * 40% = $3,600,000
New total Investment = 3,600,000 + 300,000 = $3,900,000
Weight = $3,900,000 / $9,000,000 = 43.33%
Similarly, New wieght of mid cap stocks would be = 35% + ($150,000 / $9,000,000) = 36.67%
New Beta = 0.7 * 15% + 1 * 36.67% + 1.4 * 43.33% = 1.078
New Required rate of return = 3.5 + 5 * 1.078 = 8.89%
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