Question

8. The manager of GT-KiwiSaver Fund expects the fund to earn a rate of return of 12% this year. The beta (β) of the fund's portfolio is 0.8. The rate of return available on Treasury Bills (risk-free assets) is 5% p.a. and you expect the rate of return on an NZSX50 Index Fund (the market portfolio) to be 15% p.a. a. Demonstrate whether you should invest in GT-KiwiSaver Fund or not. b. Show how you can create a portfolio, with the instruments mentioned in the question, with the same risk as GT-KiwiSaver Fund, but with a higher expected rate of return. c. Explain why in reality, a mutual fund (such as a KiwiSaver fund) must be able to provide an expected rate of return that is higher than that predicted by the security market line in order for investors to consider the fund an attractive investment opportunity.

Answer 1

1.
required return=risk free rate+beta*(market return-risk free rate)=5%+0.8*(15%-5%)=13.00%

As expected return is less than required return, do not invest

2.
Weight of market portfolio=Required Beta=0.80
Weight of risk free asset=1-weight of market portfolio=1-0.80=0.20

Invest 80% of money in market portfolio and 20% of money in risk free asset
Expected return=0.80*15%+0.20*5%=13.00%

3.
There would be some unique/unsystematic risk present in mutual fund hence an investor would be better off in investing in market portfolio when expected return is equal to required return predicted by SML. Hence, to compensate investors for the additional risk, the fund must provide higher return.

answered by: anonymous