The TIMCO Mutual Fund has total capital of $500 million invested in five stocks:

Question

The TIMCO Mutual Fund has total capital of $500 million invested in five stocks: The beta coefficient for the fund is the weighted average of the fund's investments. The current risk free rate is 6%, and the expected market return is 13.5%. a. What is the beta of the mutual fund portfolio? b. Use the CAPM and your answers to part (b) to determine the expected rate of return on the Mutual Fund. c. Suppose the Fund manager receives a proposal for a new stock. The investment needed to take a position in the stock is $50 million; it will have an expected return of 18% and its estimated beta coefficient is 2.0. Should the new stock be purchased?

Explanation / Answer

a. The beta of the mutual fund = 160/500 * 1.3 + 120/500 *0.67 + 80/500*1.3 + 80/500 * 1.02 + 60/500 *1.32 = 1.1064

Beta of the mutual fund = 1.1064

b. Expected return on mutual funs as per CAPM is = Rf + beta*(Rm - Rf) = 6 + 1.1064*(13.5-6) = 14.298 = 14.30%

c. The beta of the new stock is 2.0 which is nearly 80% higher than the average beta of the portfolio. This will increase the risk and should not be purchased.

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