Question

Hazel Morrison, a mutual fund manager, has a $40 million portfolio with a beta of 1.00. The risk-free rate is 4.25%, and the market risk premium is 6.00%. Hazel expects to receive an additional $16.00 million, which she plans to invest in additional stocks. After investing the additional funds, she wants the fund's required and expected return to be 13.00%. What must the average beta of the new stocks be to achieve the target required rate of return? Select the correct answer. a. 2.55 b. 2.60 c. 2.65 d. 2.70

Answer 1

Required return=Risk free rate+Beta*Market risk premium

Required return for $40million=4.25+1*6=10.25%

Total value now=(40+16)=$56million

Required return=Respective return*Respective weights

13=(10.25*40/56)+(Required return of new stock*16/56)

13=7.321428571+(Required returnof new stock*16/56)

Hence Required return of new stock=(13-7.321428571)*56/16

=19.875

Required return=Risk free rate+Average beta of new stock*Market risk premium

19.875=4.25+Average beta of new stock*6

Average beta of new stock=(19.875-4.25)/6

which is equal to

=2.60(Approx).

=