Henry, a direct descendant of Jefferson Morgan has inherited $450,000. A financi

Question

Henry, a direct descendant of Jefferson Morgan has inherited $450,000. A financial advisor tells her to invest this amount and target an average of at least 8% return over a 30 years. Henry decides to invest in a Northern Endowment Fund that has had a ten year average return of 8.5%. During the same time, S&P500 has had a 13% return (this is market return). The risk free return is 2% and the beta of the fund is 0.8. (15 PTS)

a) What is the discount rate? (10 PTS)

b) Would a beta of 1.1 increase her returns? (5PTS)

Explanation / Answer

Discount rate = Risk free rate + Beta (Market Rate - Risk free rate)

= 2 + 0.80(13 - 2)

= 10.80%

Return when the beta is 1.1 = 2 + 1.1 (13 - 2)

= 14.1%

Thus, the beta of 1.1 will increase her returns.

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