SECURITY MARKET LINE You plan to invest in the Kish Hedge Fund, which has total

Question

SECURITY MARKET LINE 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 $160 million 120 million 80 million 80 million 60 million 0.8 2.4 4.4 1.0 3.1 Kish's beta coefficient can be found as a weighted average of its stocks' betas. The risk-free rate is 3%, and you believe the following probability distribution for future market returns is realistic: Probability 0.1 0.2 0.4 0.2 0.1 Market Return (696) 9 14 17

Explanation / Answer

b.

Required rate of return = 0.1 * -0.06 + 0.2 * 0.09 + 0.4 * 0.11 + 0.2 * 0.14 + 0.1 * 0.17

= -0.006 + 0.018 + 0.044 +0.028 + 0.017

= 0.101 or 10.1%

c. Expected return = 14%

Expected return = 0.03 + 1.5(0.101 - 0.03)

= 0.1365 or 13.65%.

Required return of new stock is 13.65%.

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