11. PORTFOLIO BETA A mutual fund manager has a $20 million portfolio with a beta

Question

11.

PORTFOLIO BETA

A mutual fund manager has a $20 million portfolio with a beta of 1.15. The risk-free rate is 4.25%, and the market risk premium is 5.0%. 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 19%. What should be the average beta of the new stocks added to the portfolio? Do not round intermediate calculations. Round your answer to two decimal places. Enter a negative answer with a minus sign.

Explanation / Answer

Expected return before the additional funds using CAPM is

Rf + Beta*(Rm-Rf)

= 4.25% + 1.15*5%

= 4.25% + 5.75% = 10%

Now after 5 million funding, funds required return is 19%.

Thus return on new stocks is x(say). Then

19%*25 = 10%*20 + X%*5

i.e. X = (4.75% - 2%) / 5 = 55%

Now again applying CAPM

55% = 4.25% + Beta*5%

Beta = 10.15

Thus, the average Beta of the new stocks added to the portfolio needs to be 10.15

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