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

Answer 1

The correct answer 8.83%

Step-by-step explanation:

The first step is to calculate the market risk premium which will be used late in the calculation of required return

The formula of market risk premium is

(Required return - risk-free rate) ÷ Beta

= (9.5% - 4.2%) ÷ 1.05

= 5.048%

The second step is to calculate the beta of portfolio

= (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%