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	2.1
C	80 million	3.8
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 5%, and you believe the following probability distribution for future market returns is realistic:

Probability	Market Return
0.1	(5%)
0.2	8
0.4	11
0.2	14
0.1	16

What is the equation for the Security Market Line (SML)? (Hint: First determine the expected market return.)

r_i = 4.4% + (5.9%)b_i

r_i = 5.0% + (4.9%)b_i

r_i = 2.3% + (6.1%)b_i

r_i = 5.0% + (5.9%)b_i

r_i = 4.4% + (4.9%)b_i

-Select-IIIIIIIVV

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 15%, and its estimated beta is 1.4. Should Kish invest in the new company?
The new stock -Select-should notshould be purchased.

At what expected rate of return should Kish be indifferent to purchasing the stock? Round your answer to two decimal places.

Answer 1

Kish Case

a.

Weightage average Beta of portfolio is calculated in excel and screen shot provided below:

Beta of portfolio is 1.78.

Average market return =(-5% × 10%) + (8% × 20%) + (11% × 40%) + (14% × 20%) + (16% × 10%)

= -0.50% + 1.60% + 4.40% + 2.80% + 1.60%

= 9.90%

Weightage average market return is 9.0%.

Security market formula that is CAPM model is use to determine required rate of return

Required rate= Risk free rate + (Market Return - Risk free rate) × Beta

= 5% + (9.90% - 5%) × Beta

= 5% + (4.90% × Beta)

So, required return is  5% + (4.90% × Beta).

Option (B) is correct answer.

b.

Beta for Kish = 1.78

Kish Required rate =  5% + (4.90% × Beta)

= 5% + (4.90% × 1.78)

= 5% + 8.72%

= 13.72%

Kish Required rate of return is 13.72%.

c.

if beta = 1.40

Then required rate of return is calculated below:

Required rate of return = 5% + (4.90% × Beta)

= 5% + (4.90% × 1.40)

= 5% + 6.86%

= 11.86%

Kish Required rate of return is 11.86%.

Required rate of return is 11.86% and expected return is 15%.

Since,Expected return is more than required rate, so yes kish should make investment.

d.

expected rate equal to 13.72% that is expected return with 1.78 beta , should Kish be indifferent to purchasing the stock