A mutual fund manager has a $20 million portfolio with a beta of 1.25. The risk-

Question

A mutual fund manager has a $20 million portfolio with a beta of 1.25. The risk-free rate is 5.25%, and the market risk premium is 7.0%. The manager expects to receive an additional $5 million, which she plans to invest in a number of stocks. After investing the additional funds, she wants the fund's required return to be 12%. What should be the average beta of the new stocks added to the portfolio? Do not round intermediate calculations. Round your answer to two decimal places. Enter a negative answer with a minus sign.

Explanation / Answer

The Expected return of the current stocks as per CAPM (Using formulaw : Re = RF +B(Rm-Rf) is,

5.25% +1.25*7% = 14%.

Now the weights of the old and new securities shal be 20/25 = 80% and 5/25 = 20% post thew new funds are invested.

Let the required Return on New Investments be r.
We know return of the portfolio shall be weighted avg of the returns of the individual constituents.

Then,

14% * 80% + X% *20% = 12%.
or
X = 4%.

Now, using CAPM Again in the formulae for new investment,

4% = 5.25 + B(7%).
or
B= -.178 (Ans)

Ans : The new stock shall have a negative B of -0.18. (Approx)

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