You plan to invest in a portfolio fund. The fundâs total capital is $150 million, which is invested into stock FIB ($60 million) and stock ATM ($90 million). Stock FIB has a beta of 0.8 and stock ATM has a beta of 1.3. The following is probability distributions for the future possible returns of both stocks:
Probability Stock FIB Stock ATM
.3 2% -10%
.5 5% 16%
.2 14% 26%
Currently, the yield of treasury security is 2% and market risk premium is 4%.
a. Find the portfolioâs expected return
b. Find the portfolioâs beta and required return.
c. Identify whether the portfolio is undervalued, fair valued, or overvalued.
d. Explain market reaction and adjustment process in the market for this portfolio fund.
e. Draw the Security Market Line(SML), write the equation of the SML line, plot the portfolioâs required return and expected return, and indicate to which direction the expected return should move.
You plan to invest in a portfolio fund. The fundâs total capital is $150 million, which is invested into stock FIB ($60 million) and stock ATM ($90 million). Stock FIB has a beta of 0.8 and stock ATM has a beta of 1.3. The following is probability distributions for the future possible returns of both stocks:
Probability Stock FIB Stock ATM
.3 2% -10%
.5 5% 16%
.2 14% 26%
Currently, the yield of treasury security is 2% and market risk premium is 4%.
a. Find the portfolioâs expected return
b. Find the portfolioâs beta and required return.
c. Identify whether the portfolio is undervalued, fair valued, or overvalued.
d. Explain market reaction and adjustment process in the market for this portfolio fund.
e. Draw the Security Market Line(SML), write the equation of the SML line, plot the portfolioâs required return and expected return, and indicate to which direction the expected return should move.
Related questions
Keith holds a portfolio that is invested equally in three stocks (Wd = Wa = Wi = 1/3). Each stock is described in the following table:
| Stock | Beta | Standard Deviation | Expected Return |
| DET | 0.7 | 25% | 8% |
| AIL | 1.0 | 38% | 10% |
| INO | 1.6 | 34% | 13.5% |
An analyst has used market and firm-specific information to make expected return estimates for each stock. The analyst's expected return estimates may or may not equal the stocks' required returns.
The risk-free rate (Rf) is 6% and the market risk premium (Rp) is 4%. Use the following graph with the security market line (SML) to plot each stock's beta and expected return.
A stock is in equilibrium if its required return ___________ its expected return. In general, assume that markets and stocks are in equilibrium (or fairly valued), but sometimes investors have different opinions about a stock's prospects and may think that a stock is out of equilibrium (either undervalued or overvalued). Based on the analyst expected return estimates, stock INO is ___________, stock AIL is equilibrium, and stock DET is _________.
| probability of the state of economic | Rate of return STOCK A | if states STOCK B | occurs STOCK C | |
| boom | 0,2 | 0,4 | -0,04 | 0,12 |
| good | 0,3 | 0,2 | 0,05 | 0,08 |
| poor | 0,4 | 0,04 | 0,1 | 0,02 |
| burst | 0,1 | -0,06 | 0,14 | 0 |
Calculate the expected return of each stock.
b. Calculate the variance and standard deviation of each stock.
c. Calculate the expected return of the portfolio (Portfolio1) consisting 40% of stock A,
40% of stock B and 20% of stock C.
d. Calculate the variance and standard deviation of this portfolio.
e. Consider an alternative portfolio (Portfolio2) 40% of stock A, 20% of stock B, 10% of
stock C and 30% in the risk-free asset. Risk-free asset expected return is 2%. What is
this portfolioâs expected return, variance and standard deviation?
f. Based on CAPM calculate each stock beta if market risk premium is 5%.
g. Which stock has the lowest systematic risk? Which stock has the lowest total risk?
Which stock is âsafestâ? Explain.
h. What is the beta of the Portfolio1 and Portfolio?
