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 0.7 B 120 million 1.1 C 80 million 1.8 D 80 million 1.0 E 60 million 1.8 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 -25 % 0.2 0 0.4 13 0.2 28 0.1 47 What is the equation for the Security Market Line (SML)? (Hint: First determine the expected market return.) ri = 1.0% + (11.6%)bi ri = 3.0% + (9.2%)bi ri = 1.9% + (10.0%)bi ri = 1.9% + (9.2%)bi ri = 3.0% + (10.0%)bi -Select-IIIIIIIVVItem 1 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 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.   % 8.11

Answer 1

i. Expected Market Return = Probability * Respective Market Return

Expected Market Return = 0.10 * -25% + 0.2 * 0% + 0.4 * 13% + 0.20 * 28% + 0.1 * 47%

Expected Market Return = 13%

a. Equation of SML = Risk Free Rate + (Market Return - Risk Free Rate) * Beta

Equation of SML = 3% + (13% - 3%) * Beta

Equation of SML = 3% + 10% * bi Option V

b. Kish's Required Rate of Return

Kish's Beta Coefficient

Kish's Required Rate of Return = 3% + 10% * bi

Kish's Required Rate of Return = 3% + 10% * 1.152

Kish's Required Rate of Return = 14.52%

c. Analysis:

Required return of Proposed stock = 3% + 10% * Beta

Required return of Proposed stock = 3% + 10% * 1.50

Required return of Proposed stock = 18%

As the expected return from proposed stock is 17% which is less than 18% of required return. thus

The new stock should not be purchased.\

When the expected return is equal to required rate of return then kish's is indifferent in purchasing stock i.e., 18.00%