Question

In: Finance

Company X has a beta of 0.70, while Company Y's beta is 1.20. The required return...

Company X has a beta of 0.70, while Company Y's beta is 1.20. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. A fund has $3500 invested in company X stock and $4500 invested in the stock of company Y. a) What is fund's required rate of return? b) Suppose you sell all of your holdings in stock Y and invest $4500 in stock Z having beta of 1.5. What is the fund's new beta after this transaction?

Kindly mention Calculator keys if applicable

Solutions

Expert Solution

Solution a) Beta of Stock X = 0.70

Investment in stock X = $3500

Beta of Stock Y = 1.20

Investment in stock Y = $4500

Total investment in the fund = Investment in stock X + Investment in stock Y

= $3500 + $4500 = $8000

Weight of stock X in the fund = Investment in stock X/Total investment in the fund

= 3500/8000 = 43.75%

Weight of stock Y in the fund = Investment in stock Y/Total investment in the fund

= 4500/8000 = 56.25%

Beta of the fund = ∑Weight of Individual Security in a Portfolio×Beta of Individual Security

Beta of the fund = 43.75%*0.70 + 56.25%*1.20 = 0.98125

According to the Capital Asset Pricing Model (CAPM), the required return of the fund = Risk-free rate + Beta*(Market return - Risk-free rate)

Required return of the fund (using CAPM) = Rf + beta* (Rm - Rf)

where Rf = risk-free rate = 4.25%;

Rm = market return = 11%

Hence, the required return of the fund = 4.25% + 0.98125*(11% - 4.25%)

= 4.25% + 0.98125*6.75%

= 4.25% + 6.6234375%

= 10.87%

Solution b) All of the holdings in stock Y are sold and $4500 are invested in stock Z having beta of 1.5.

Beta of Stock X = 0.70

Investment in stock X = $3500

Beta of Stock Z = 1.50

Investment in stock Z = $4500

Total investment in the fund = Investment in stock X + Investment in stock Z

= $3500 + $4500 = $8000

Weight of stock X in the fund = Investment in stock X/Total investment in the fund

= 3500/8000 = 43.75%

Weight of stock Z in the fund = Investment in stock Z/Total investment in the fund

= 4500/8000 = 56.25%

Beta of the fund = ∑Weight of Individual Security in a Portfolio×Beta of Individual Security

Beta of the fund = 43.75%*0.70 + 56.25%*1.5 = 1.15

Hence, beta of the new portfolio = 1.15


Related Solutions

Company A has a beta of 0.70, while Company B's beta is 1.10. The required return...
Company A has a beta of 0.70, while Company B's beta is 1.10. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.) Select the correct answer. a. 2.50% b. 2.55% c. 2.60% d. 2.65% e. 2.70%
Company A has a beta of 0.70, while Company B's beta is 1.15. The required return...
Company A has a beta of 0.70, while Company B's beta is 1.15. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)
1. Company A has a beta of 0.75, while Company B's beta is 1.20.The required...
1. Company A has a beta of 0.75, while Company B's beta is 1.20. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)2. Emc corporation has never paid a dividend. its current free cash flow of 400000 is expected to grow at a constant rate of 5...
If a company has a beta of 1.3, the required rate of return on this company...
If a company has a beta of 1.3, the required rate of return on this company fs stock is 10.3 percent and the risk-free rate is currently 1.2 percent, what should be the excess market return at the moment. Use the idea of capital asset pricing model.
Beale Manufacturing Company has a beta of 1.4, and Foley Industries has a beta of 0.70....
Beale Manufacturing Company has a beta of 1.4, and Foley Industries has a beta of 0.70. The required return on an index fund that holds the entire stock market is 11%. The risk-free rate of interest is 4.5%. By how much does Beale's required return exceed Foley's required return? Do not round intermediate calculations. Round your answer to two decimal places.   %
BETA AND REQUIRED RATE OF RETURN a. A stock has a required return of 9%; the...
BETA AND REQUIRED RATE OF RETURN a. A stock has a required return of 9%; the risk-free rate is 5%; and the market risk premium is 3%. What is the stock's beta? Round your answer to two decimal places. b. If the market risk premium increased to 10%, what would happen to the stock's required rate of return? Assume that the risk-free rate and the beta remain unchanged. If the stock's beta is equal to 1.0, then the change in...
Beta and required rate of return A stock has a required return of 12%; the risk-free...
Beta and required rate of return A stock has a required return of 12%; the risk-free rate is 2.5%; and the market risk premium is 3%. What is the stock's beta? Round your answer to two decimal places. B. If the market risk premium increased to 9%, what would happen to the stock's required rate of return? Assume that the risk-free rate and the beta remain unchanged. 1. If the stock's beta is equal to 1.0, then the change in...
ABC's well-diversified portfolio has an expected return of 12.0% and a beta of 1.20. She is...
ABC's well-diversified portfolio has an expected return of 12.0% and a beta of 1.20. She is in the process of buying 100 shares of XYZ Corp. at $20 a share and adding it to her portfolio. XYZ has an expected return of 15.0% and a beta of 1.80. The total value of your current portfolio is $8,000. What will the expected return and beta on the portfolio be after the purchase of the XYZ stock? A. 12.60%; 1.32 B. 12.40%;...
5-Company A stock has a beta of 1.40, and its required return is 12.00%. Company B...
5-Company A stock has a beta of 1.40, and its required return is 12.00%. Company B stock has a beta of 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock?
Stock J has a beta of 1.5 and an expected return of 15%, while Stock K has a beta of .75 and an expected return of 9%.
Stock J has a beta of 1.5 and an expected return of 15%, while Stock K has a beta of .75 and an expected return of 9%. You want a portfolio with the same risk as the market. What is the expected return of your portfolio?Group of answer choices10 percent11 percent12 percent13 percent14 percent
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT