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ADM 2337 Lecture Notes - Lecture 3: Risk-Free Interest Rate, Capital Asset Pricing Model

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School
University of Ottawa
Department
Administration
Course
ADM 2337
Professor
Catherine Elliott

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Document Summary

Example 10 (problem 7-13): you plan to invest in a hedge fund that has total capital of million invested in 5 stocks: The risk-free rate is 6%, and you believe that the following probability distribution for future market returns is realistic: The hedge fund receives a proposal from a company seeking new capital. The amount needed to take a position on the stock is million. The stock has an expected return of 15% and its estimated beta is 2. 0. Current beta of this hedge fund is -=0. 16+0. 48+0. 64+0. 16+0. 36=1. 8, Thus fund"s current expected return (using capm) should be =0. 15 or 15% New stock has beta=2, so, return on it should be =0. 16 or 16%. Example 11 (problem 7-14): you have a mln portfolio consisting of a ,000 investment in each of 20 different stocks. The portfolio has a beta equal to 1. 1.

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Related Questions

You plan to invest in the kish hedge fund, which has a total capital of $500 million invested in five stocks.

Stocks Investments Stock's Beta Coefficient

a $160 million 0.5
b 120 million 1.2
c 80 million 1.8
d 80 million 1.0
e 60 million 1.6

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 return is realistic.

Probability Market Return

0.1 -28%
0.2 0
0.4 12
0.2 30
0.1 50

A. What is the equation for the Security Market Line?

B. Calculate Kish's required rate of return

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 15%, and its estimated beta is 1.5. Should Kish invest in the new company? At what expected rate of return should Kish be indifferent to purchasing the stock?

The McAlhany Investment Fund has total capital of $500 millioninvested in five stocks:

Stock A: Investment $160 Million Stock's Beta Coefficient 0.5
Stock B: Investment $120 Million Stock's Beta Coefficient 2.0
Stock C: Investment $ 80 Million Stock's Beta Coefficient 4.0
Stock D: Investment $ 80 Million Stock's Beta Coefficient 1.0
Stock E: Investment $ 60 Million Stock's Beta Coefficient 3.0

The Current risk free rate is 8 percent. Market returns have thefollowing estimated probability distribution for the nextperiod:

Probability Market Return
0.1 10%
0.2 12%
0.4 13%
0.2 16%
0.1 17%

A. Compute the expected return for the market
B. Compute the beta coefficient for the investment fund.
C. What is the estimated equation for the security marketline?
D. Compute the fund's required rate of return for the nextperiod
E. Suppose John McAlhany, the president, receives a proposal for anew stock. The investment needed to take a position in the stock is$50 million, it will have an expected return of 18%, and itsestimated beta coefficient is 2.0. Should the firm purchase the newstock? At what expected rate of return should McAlhany beindifferent to purchasing the stock?

The Apple Bee Investment Fund has a total investment of $600 million in five stocks.

Stock

Investment (Millions)

Beta

A

230

1.4

B

210

1.5

C

70

1.0

D

90

2.0

What is the fund’s overall, weighted average, beta?

If the risk-free rate is 5% and the market return is 11%, what is the required rate of return on the Apple Fund?

Let assume IBM’s beta is the same as what you calculated in a. Several analysts predict that IBM’s expected return for next year will be 15%, is IBM over or undervalued?