Question

Assume that you are the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks. The required rate of return on the market is 11.00% and the risk-free rate is 5.00%. What rate of return should investors expect (and require) on this fund? Stock Amount Beta A $1,075,000 1.20 B 675,000 0.50 C 750,000 1.40 D 500,000 0.75 Total $3,000,000 10.56% 10.83% 11.11% 11.38% 11.67%

Answer 1

Answer:

11.11%

Explanation:

The full question with table is attached.

We need the rate of return formula using Capital Asset Pricing Model (CAPM). The formula is:

$R=R_f+\beta(R_m-R_f)$

Where

R is rate of return (what we need)

$R_f$ is risk-free return rate (5% = 0.05)

$R_m$ is the market rate of return (11% = 0.11)

To get $\beta$, we take the weighted average of the portfolio.

Weight of Stock A = 1,075,000/3,000,000 = 0.3583

Weight of Stock B = 675,000/3,000,000 = 0.225

Weight of Stock C = 750,000/3,000,000 = 0.25

Weight of Stock D = 500,000/3,000,000 = 0.1667

Portfolio Beta = (0.3583*1.2) + (0.225*0.50) + (0.25*1.40) + (0.1667*0.75) = 1.02  

Now, we calculate rate of return using CAPM formula:

$R=R_f+\beta(R_m-R_f)\\R=0.05+1.02(0.11-0.05)\\R=0.1112$

That is 11.12%, or from answer choice, it is 11.11%