A mutual fund manager has a $20 million portfolio with a beta of 1.25. The risk-

Question

A mutual fund manager has a $20 million portfolio with a beta of 1.25. The risk-free rate is 5.25%, and the market risk premium is 4.0%. 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 14%. 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

Required rate of the initial portfolio:

According to CAPM,

Required rate = risk free rate + beta*market risk premium

= 5.25% + 1.25*4% = 10.25%

Calculate the required return of the additional funds,

Required rate of the portfolio is the weighted average of individual returns.

14% = 20/(20+5) * 10.25% + 5/(20+5) * x

x = 29.00%

Now, calculate the beta using CAPM,

29% = 5.25% + beta*4%

beta = 5.94

Beta of new stocks = 5.94

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