Question

You plan to invest in the Kish Hedge Fund, which has total capital of $500 million invested in five stocks: Stock Stock's Beta Coefficient 1.6 Investment $160 million 120 million 80 million 80 million 60 million 2.0 1.0 1.3 Kish's beta coefficient can be found as a weighted average of its stocks' betas. The risk-free rate is 4%, and you believe the following probability distribution for future market returns is realistic: Probability Market Return -26% 0.1 0.2 0.4 0.2 28 0.1 a. What is the equation for the Security Market Line (SML)? (Hint: First determine the expected market return.) I. n = 3.1% + (9.9%)bi II. r = 3.1% + (9.2%)bi III. r = 4.0% + (9.9%)bi IV. n = 4.9% + (11.1%)bi V. r = 4.0% + (9.2%)bi -Select- b. Calculate Kish's required rate of return. Do not round intermediate calculations. Round your answer to two decimal places. c. 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 1.4. Should Kish invest in the new company? The new stock -Select- 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

a Expected market return Z Prob.x market return) = 0.IX (-26)+ 0.2x0+ 0.40 14 + 0.2 x 28+ 0.1 x 53 = 13.9 % 6 avereal Equation of Security market line & = Risk free t (Market retum-sisk free) x b; 8 = 4+ (13.9 -4 ) b; Hence, di = 4+ 9.9 6; Correct option is (II) Bete of kish hedge fund = weighted average - 160 x0.3 + 120 x 16 + de x2 + 80 x I +60 x 1.3 = 1:116 kish's required return = 4+9.941.116 = 15.05 % return on proposal = 4 7 9.9 x 14 = 17.86 % Expected return = 17 % Hence, kish should not invest in new Company because Experted return is less than required return. ooo Soo

kish would be indifferent whon Expected return = Required return Hence, At 17.86 % , kish would be indifferent