You plan to invest in the Kish Hedge Fund, which has total capital of $500 milli

Question

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 A $160 million 0.3 B 120 million 2.2 C 80 million 4.5 D 80 million 1.0 E 60 million 3.4 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 Market Return 0.1 (7%) 0.2 10 0.4 12 0.2 14 0.1 15 What is the equation for the Security Market Line (SML)? (Hint: First determine the expected market return.) ri = 2.7% + (7.4%)bi ri = 2.7% + (9.1%)bi ri = 3.0% + (7.4%)bi ri = 5.2% + (7.2%)bi ri = 3.0% + (9.1%)bi Calculate Kish's required rate of return. Do not round intermediate calculations. Round your answer to two decimal places. % Suppose Rick Kish, the president, receives a proposal from a company seeking new capital. The amount needed to take a position in the stock is $50 million, it has an expected return of 14%, and its estimated beta is 1.5. Should Kish invest in the new company? The new stock be purchased. At what expected rate of return should Kish be indifferent to purchasing the stock? Round your answer to two decimal places. %

Explanation / Answer

Expected market return=0.1*7%+0.2*10%+0.4*12%+0.2*14%+0.1*15%=11.8%

Beta of portfolio=(160*0.3+120*2.2+80*4.5+80*1+60*3.4)/(160+120+80+80+60)=1.912

Given, Risk free rate=3%

Market risk premium=market return-risk free=11.8-3=8.8%

Equation of SML: return=risk free+beta*market risk premium

Hence, SML: return=3%+beta*8.8%

Required return=3%+1.912*8.8%=19.8256%

new stock should have return of 3+1.5*8.8=16.2%

But as the stock is offering just 14%, Kish should not invest in the stock

At 16.2% he would be indifferent to purchasing the stock

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.