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	0.8
B	120 million	1.6
C	80 million	1.7
D	80 million	1.0
E	60 million	1.9

Kish's beta coefficient can be found as a weighted average of its stocks' betas. The risk-free rate is 6%, and you believe the following probability distribution for future market returns is realistic:

Probability	Market Return
0.1	-25	%
0.2	0
0.4	14
0.2	32
0.1	49

1. What is the equation for the Security Market Line (SML)? (Hint: First determine the expected market return.)
   1. r_i = 9.5% + (10.4%)b_i
   2. r_i = 6.0% + (8.4%)b_i
   3. r_i = 5.0% + (7.3%)b_i
   4. r_i = 6.0% + (10.4%)b_i
   5. r_i = 9.5% + (8.4%)b_i

   -Select-IIIIIIIVVItem 1

2. Calculate Kish's required rate of return. Do not round intermediate calculations. Round your answer to two decimal places.

     %

3. 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 17%, and its estimated beta is 1.5. Should Kish invest in the new company?

   The new stock -Select-should notshouldItem 3 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

1. Market Return = 0.1 * -25% + 0.4 * 14% + 0.2 * 32% + 0.1 * 49% = 14.4%

a. equation for the Security Market Line = Risk Free + Beta (Market return - risk free)

equation for the Security Market Line = 6% + Beta * 8.4% Option II

b. Kish's required rate of return = 6% + Beta * 8.4%

Kish's required rate of return = 6% + 1.30 * 8.4%

Kish's required rate of return = 16.92%

c. Expected Return of new stock = 6% + Beta * 8.4%

Expected Return of new stock = 6% + 1.50 * 8.4% = 18.60%

as the expected return is higher than portfolio's expected return .

The new stock should be purchased

d. at 18.60% the kish will be at indifferent