Question

The $10.00 million mutual fund Henry manages has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. Henry now receives another $5.00 million, which he invests in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.)

Answer 1

8.83%

Step-by-step explanation:

Market risk premium = (required return - risk-free rate) ÷ Beta

= (9.5% - 4.2%) ÷ 1.05

= 5.048%

Beta of portfolio:

= (Mutual fund ÷ Total of MF) × Beta + (New investment ÷ Total of MF) × Average beta

= (10 ÷ 15) × 1.05 + (5 ÷ 15) × 0.65

= 0.9167

Required return:

= Risk-free rate + Beta of portfolio × Market risk premium

= 4.2% + 0.9167 × 5.048%

= 8.83%