Suppose you are the money manager of a $4 million investmentfund. The fund consi

Question

Suppose you are the money manager of a $4 million investmentfund. The fund consist of 4 stocks with the followinginvestments and betas. Stock         Investment         Beta A            $400,000               1.50 B            $600,000               (0.50) C         $1,000,000               1.25 D         $2,000,000               0.75 If the market's required rate of return is 14 percent and therisk-free rate is 6 percent, what is the fund's required rate ofreturn? Suppose you are the money manager of a $4 million investmentfund. The fund consist of 4 stocks with the followinginvestments and betas. Stock         Investment         Beta A            $400,000               1.50 B            $600,000               (0.50) C         $1,000,000               1.25 D         $2,000,000               0.75 If the market's required rate of return is 14 percent and therisk-free rate is 6 percent, what is the fund's required rate ofreturn?

Explanation / Answer

$4,000,000

Stock

InvestmentAmount

Beta

Investment in Stock A

$400,000

1.50

Investment in Stock B

$600,000

(0.50)

Investment in Stock C

$1,000,000

1.25

Investment in Stock D

$2,000,000

0.75

Total InvestmentValue

$4,000,000

Stock

PortfolioWeight

A

B

C

D

Total InvestmentValue

$4,000,000

Stock

InvestmentAmount

Beta

Investment in Stock A

$400,000

1.50

Investment in Stock B

$600,000

(0.50)

Investment in Stock C

$1,000,000

1.25

Investment in Stock D

$2,000,000

0.75

Total InvestmentValue

$4,000,000

Stock

PortfolioWeight

A

($400,000 / $4,000,000)    = 0.10

B

($600,000 / $4,000,000)    = 0.15

C

($1,000,000 /$4,000,000) = 0.25

D

($2,000,000 /$4,000,000) = 0.50 Portfolio Beta(ßP) of the Stock = (0.10 * 1.50) + (0.15* -0.50) + (0.25 * 1.25) + (0.50 * 0.75) Portfolio Beta(ßP) = 0.15 + (-0.075) + 0.3125 +0.375 Portfolio Beta(ßP) = 0.7625 Market Rate of Return(RM) = 14% Risk-free Rate(Rf) = 6% Portfolio Beta(ßP) = 0.7625 Funds Required Rate ofReturn (RE) = ? RE = Rf + ß (RM- Rf) RE = 0.06 + 0.7625 (0.14 -0.06) RE = 0.06 +0.7625 (0.08) RE = 0.06 +0.061 Required Rate of Return(RE) = 0.121 (or) 12.10% Fund's RequiredRate of Return(RE) = 12.10%

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