Question

A mutual fund manager has a $20 million portfolio with a beta of 1.40. The risk-free rate is 5.75%, and the market risk premium is 5.5%. 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 14%. What should be the average beta of the new stocks added to the portfolio? Negative value, if any, should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Beta of new portfolio:

As per CAPM

expected return = risk-free rate + beta * (Market risk premium)

14 = 5.75 + Beta * (5.5)

Beta = 1.5

Total new Portfolio value = Value of Current portfolio + Value of Additional investment

=20+5

=25

Weight of Current portfolio = Value of Current portfolio/Total new Portfolio Value

= 20/25

=0.8

Weight of Additional investment = Value of Additional investment/Total new Portfolio Value

= 5/25

=0.2

Beta of new Portfolio = Weight of Current portfolio*Beta of Current portfolio+Weight of Additional investment*Beta of Additional investment

1.5 = 1.4*0.8+Beta of Additional investment*0.2

Beta of Additional investment = 1.9