The Apple Bee Investment Fund has a total investment of $600 million in five sto
ID: 2766675 • Letter: T
Question
The Apple Bee Investment Fund has a total investment of $600 million in five stocks.
Stock
Investment (Millions)
Beta
A
230
1.4
B
210
1.5
C
70
1.0
D
90
2.0
What is the fund’s overall, weighted average, beta?
If the risk-free rate is 5% and the market return is 11%, what is the required rate of return on the Apple Fund?
Let assume IBM’s beta is the same as what you calculated in a. Several analysts predict that IBM’s expected return for next year will be 15%, is IBM over or undervalued?
Stock
Investment (Millions)
Beta
A
230
1.4
B
210
1.5
C
70
1.0
D
90
2.0
Explanation / Answer
Weighted Average beta = 1.4 * 230/600 + 1.5 * 210/600 + 1 * 70/600 + 2 * 90/600
= 0.5367 + 0.525 + 0.1167 + 0.30 = 1.4784
#Total Investment = 230 + 210 + 70 + 90 = 600
Required Rate of Return = Risk free Return + Beta * (Market Rate - Risk free Return)
A = 5% + 1.4 * (11% - 5%) = 13.40%
B = 5% + 1.5 * (11% - 5%) = 14%
C = 5% + 1.0 * (11% - 5%) = 11%
D = 5% + 2 * (11% - 5%) = 17%
Required Rate of Return of Apple Fund = 13.4% * 230/600 + 14% * 210/600 + 11% * 70/600 + 17% * 90/600
= 5.14% + 4.9% + 1.28% + 2.55% = 13.87%
If IBM’s beta is the same as what you calculated in a, then the required rate of return would be 13.87%. However, if IBM’s expected return for next year will be 15%, the actual expected return is higher than expected, this shows share is overvalued.If the expected return using the CAPM is lower than the investor's required return, the security is overvalued and should be sold.
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