Question

Suppose you are the money manager of a $5.21 million investment fund. The fund consists of four stocks with the following investments and betas: Stock Investment Beta A $ 440,000 1.50 B 440,000 (0.50) C 1,380,000 1.25 D 2,950,000 0.75 If the market's required rate of return is 11% and the risk-free rate is 5%, what is the fund's required rate of return? Do not round intermediate calculations. Round your answer to two decimal places

Answer 1

The fund's required rate of return is computed as shown below:

= Risk free rate + Beta ( return on market - risk free rate)

Beta is computed as follows:

= Beta of A x Weight of A + Beta of B x Weight of B + Beta of C x Weight of C + Beta of D x Weight of D

= 1.50 x $ 440,000 / $ 5,210,000 - 0.50 x $ 440,000 / $ 5,210,000 + 1.25 x $ 1,380,000 / $ 5,210,000 + 0.75 x $ 2,950,000 / $ 5,210,000

= 0.840211132

So, the fund's required rate of return will be computed as follows:

= 0.05 + 0.840211132 ( 0.11 - 0.05)

= 10.04% Approximately