Question

You plan to invest in the Kish Hedge Fund, which has total capital of $500 million invested in five stocks:

Stock

Investment

Stock's Beta Coefficient

A	$160 million	0.5
B	120 million	2.0
C	80 million	4.0
D	80 million	1.0
E	60 million	3.2

Kish's beta coefficient can be found as a weighted average of its stocks' betas. The risk-free rate is 6%, and you believe the following probability distribution for future market returns is realistic:

Probability

Market Return

0.1	(5%)
0.2	9
0.4	11
0.2	14
0.1	17

a.) Calculate Kish's required rate of return. Do not round intermediate calculations. Round your answer to two decimal places.

b.)  Suppose Rick Kish, the president, receives a proposal from a company seeking new capital. The amount needed to take a position in the stock is $50 million, it has an expected return of 14%, and its estimated beta is 1.5. Should Kish invest in the new company? The new stock SHOULD be purchased.

At what expected rate of return should Kish be indifferent to purchasing the stock? Round your answer to two decimal places.

Answer 1

Inv	Wt	Beta			prob	Return
160	0.32	0.5	0.16		0.1	5
120	0.24	2	0.48		0.2	9
80	0.16	4	0.64		0.4	11
80	0.16	1	0.16		0.2	14
60	0.12	3.2	0.384		0.1	17
500
	Beta	1.824			Market return	11.2

Required rate of return = rf+beta(market return - risk free)
=6+1.824(11.2-6)=15.48%

b) At beta of 1.5, return should be = 6+1.5(11.2-6)=13.80%
Since return is 14% which is more , the new stock should be purchased

Kish should be indifferent at 13.80%