Ok, the question read:
You have be managing a $5 million portfolio that has a beta of 1.25 and a required rate of return of 12%. The current risk-free rate is 5.25%. Assume that you own another $500000. If you invest the money in a stock beside a beta of .75, what will be the required return on your $5.5 million portfolio?
I came up beside the new beta for the portfolio as:
b = 1.25+(500000/5500000)*.75 = 1.32
and
to grasp the required rate of return on the market (Km) I get:
12=5.25+1.25(Km-5.25)
Km=10.65
Kp (required rate of return for portfolio) = 5.25+1.32(10.65 - 5.25) = 12.378
However, my professor's answer is Kp=11.75.anyone know where I go wrong??
Thanks!!
Answers: car,
I worked through your problem and here's my assessment of your answer. First, it looks close to you calculated Km correctly using the CAPM formula.
The point that you went wrong be in calculating the beta of the alien $5.5M portfolio.
Ignoring the calculations for a moment and thinking roughly speaking what you're doing with your portfolio: you switch on with a portfolio of $5.0M next to a beta 1.25. You're then accumulation in an second $500K of securities that have a lower beta than your productive portfolio. Effectively, what you're doing is "diluting" or diminishing your original portfolio's beta. As a consequence, your alien $5.5M portfolio should have a LOWER beta than the unproved. In your calculation, you're showing a beta of 1.32, which is in fact a slight increase in the portfolio's beta. This should be a tip-off that the division isn't agreeing with the intuition I in recent times described.
The beta for the new $5.5M portfolio will be a weighted average of the beta for the ancient $5.0M portion and the newer $500K portion:
b = (1.25)*(5,000,000/5,500,000) + (0.75)*(500,000/5,500,000)
= 0.068 + 1.136
= 1.204
Using a beta of 1.204 will get you your professor's answer of 11.75:
Kp = 5.25 + (1.204)*(10.65 - 5.25) = 11.75
I hope this help.
Resolved Questions:
Types of Bank?
Do you know net moniker that Calculate RSI for the stocks?
I hold 100 share but sold 200 shares contained by F&O what will be the fine?
Should the stock marketplace be abolish?
Where can I buy one of those coats population where on earth on the stock open market floor?
You have be managing a $5 million portfolio that has a beta of 1.25 and a required rate of return of 12%. The current risk-free rate is 5.25%. Assume that you own another $500000. If you invest the money in a stock beside a beta of .75, what will be the required return on your $5.5 million portfolio?
I came up beside the new beta for the portfolio as:
b = 1.25+(500000/5500000)*.75 = 1.32
and
to grasp the required rate of return on the market (Km) I get:
12=5.25+1.25(Km-5.25)
Km=10.65
Kp (required rate of return for portfolio) = 5.25+1.32(10.65 - 5.25) = 12.378
However, my professor's answer is Kp=11.75.anyone know where I go wrong??
Thanks!!
Which type of investment vehicle produces the best APR for your investment?
Answers: car,
I worked through your problem and here's my assessment of your answer. First, it looks close to you calculated Km correctly using the CAPM formula.
The point that you went wrong be in calculating the beta of the alien $5.5M portfolio.
Ignoring the calculations for a moment and thinking roughly speaking what you're doing with your portfolio: you switch on with a portfolio of $5.0M next to a beta 1.25. You're then accumulation in an second $500K of securities that have a lower beta than your productive portfolio. Effectively, what you're doing is "diluting" or diminishing your original portfolio's beta. As a consequence, your alien $5.5M portfolio should have a LOWER beta than the unproved. In your calculation, you're showing a beta of 1.32, which is in fact a slight increase in the portfolio's beta. This should be a tip-off that the division isn't agreeing with the intuition I in recent times described.
The beta for the new $5.5M portfolio will be a weighted average of the beta for the ancient $5.0M portion and the newer $500K portion:
b = (1.25)*(5,000,000/5,500,000) + (0.75)*(500,000/5,500,000)
= 0.068 + 1.136
= 1.204
Using a beta of 1.204 will get you your professor's answer of 11.75:
Kp = 5.25 + (1.204)*(10.65 - 5.25) = 11.75
I hope this help.
Resolved Questions: