A pension fund manager is considering three mutual funds. The first is a stock f

Question

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a longterm government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 5.9%. The probability distributions of the risky funds are: The correlation between the fund returns is.0721. What is the expected return and standard deviation for the minimum-variance portfolio of the two risky funds? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Explanation / Answer

Current stock price = $36

Expected rate of return = 11%

Risk free rate = 4%

Risk premium = 9%

Company expect to pay constant dividend I perpetuity. So current dividend is calculated below:

Current dividend = $36 × 11%

                               = $3.96.

Now calculate beta of existing expected rate of return by using CAPM model:

Expected rate of return = Risk free rate + Risk Premium × Beta

                              11% = 4% + 9% × beta

                               7% = 9% × beta

                            Beta = 0.78

Beta of existing expected rate of return is 0.78.

Now expected rate of return is calculated below if beta become twice.

Expected rate of return = Risk free rate + Risk Premium × Beta

                                      = 4% + 9% × 0.78 × 2

                                      = 5% + 14%

                                      = 19%

Stock price if beta become twice = $3.96 / 19%

                                                     = $20.84

Hence, Stock price become $20.84, when beta of expected return become twice.

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