A mutual fund manager expects her portfolio to earn a rate of return of 10% this

Question

A mutual fund manager expects her portfolio to earn a rate of return of 10% this year. The beta of her portfolio is .9. Assume rate of return available on risk-free assets is 3% and you expect the rate of return on the market portfolio to be 13%.

Calculate the expected rate of return that investors will demand of the portfolio.

A mutual fund manager expects her portfolio to earn a rate of return of 10% this year. The beta of her portfolio is .9. Assume rate of return available on risk-free assets is 3% and you expect the rate of return on the market portfolio to be 13%.

Explanation / Answer

a)

We have:

Rf= 3%

Rm = 13%

B = 0.90

Expected return on portfolio using CAPM:

ERp = Rf + (Rm-Rf)xB

        = 0.03 + ( 0.13 -0.03)x0.90

        = 12%

b)

No, they should not invest in the mutual fund as fair return as per CAPM is 12% whereas it is expecting to generate 10%, therefore the fund is overvalued and it should not be invested in .

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