Jimenez, Angel Kaye BSA-2nd Year September 28, 2020

ACC 216 9:45-11:45

CAPM: Portfolio Beta; Required Rates of Return

Instruction: Determine the correct answer from the given choices. Show supporting computations.

Problem 1

Mikkelson Corporation's stock had a required return of 11.75% last year, when the risk-free rate was
5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the
market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the
company's new required rate of return? (Hint: First calculate the beta, then find the required return.)

a. 14.38%

b. 14.74%

c. 15.11%

d. 15.49%

e. 15.87% Given:
Given: Risk-free rate = 5.50%
Risk-free rate = 5.50% Beta = 1.315789
Old market risk premium = 4.75% New market risk premium = 6.75%
Old required return = 11.75% New required return = ?
(𝒐𝒍𝒅 𝒓𝒆𝒕𝒖𝒓𝒏 − 𝑹𝒇 )
𝒃= 𝑁𝑒𝑤 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 𝑅𝑅𝐹 + (𝑏)(𝑅𝑃𝑀 )
𝒐𝒍𝒅 𝑹𝑷𝑴
𝑁𝑒𝑤 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 5.50% + (1.32)(6.75%)
(𝟏𝟏. 𝟕𝟓% − 𝟓. 𝟓𝟎%)
𝒃= 𝑁𝑒𝑤 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 5.50% + 8.881575%
𝟒. 𝟕𝟓
𝟔. 𝟐𝟓 𝑁𝑒𝑤 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 14.38158
𝒃=
𝟒. 𝟕𝟓
𝒃 = 𝟏. 𝟑𝟏𝟓𝟕𝟖𝟗
𝒃 = 𝟏. 𝟑𝟐
Problem 2

Assume that you manage a P10.00 million mutual fund that has a beta of 1.05 and a 9.50% required
return. The risk-free rate is 4.20%. You now receive another P5.00 million, which you invest 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.)

a. 8.83%

b. 9.05%

c. 9.27%

d. 9.51%

e. 9.74%

Given Given:
Old funds = $10,000,000 New portfolio Required Return =?
New funds (millions) = $5,000,000 Old portfolio's beta =1.05
Required return, old stocks = 9.50% New stocks' beta =0.650
Risk-free rate = 4.20% New portfolio beta =0.9167
Old Beta = 1.05

𝑀𝑎𝑟𝑘𝑒𝑡 𝑟𝑖𝑠𝑘 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 = 𝑟𝑅𝐹 + (𝑏)(𝑅𝑃𝑀 ) 𝑁𝑒𝑤 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 𝑟𝑅𝐹 + (𝑛𝑒𝑤 𝑏𝑒𝑡𝑎)(𝑅𝑃𝑀 )
9.5% = 4.2% + (1.05)(𝑅𝑃𝑀 ) 𝑁𝑒𝑤 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 4.20% + (0.9167)(5.05)
9.5% − 4.2%
𝑅𝑃𝑀 = 𝑁𝑒𝑤 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 4.20% + 4.629335
1.05
𝑁𝑒𝑤 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 8.829335
𝑹𝑷𝑴 = 𝟓. 𝟎𝟓%
𝑵𝒆𝒘 𝑷𝒐𝒓𝒕𝒇𝒐𝒍𝒊𝒐 𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝑹𝒆𝒕𝒖𝒓𝒏 = 𝟖. 𝟖𝟑

New Portfolio Beta

Funds Weighted Beta New Portfolio Beta

a b = a / Total Amount c bxc
Old 10 million (10M / 15M) = 2/3 1.05 0.7
New 5 million (5M / 15M) = 1/3 0.65 0.2167
Total 15 million New Portfolio Beta = 0.9167
Problem 3

Assume that you are the portfolio manager of the SF Fund, a P3 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 P1,075,000 1.20

B 675,000 0.50

C 750,000 1.40

D 500,000 0.75

P3,000,000

a. 10.56% b. 10.83% c. 11.11% d. 11.38% e. 11.67%

Given:

Required market return = 11.00%

Risk free rate = 5.00%

𝑀𝑎𝑟𝑘𝑒𝑡 𝑅𝑖𝑠𝑘 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 = 𝑅𝑀 + 𝑟𝑅𝐹

𝑀𝑎𝑟𝑘𝑒𝑡 𝑅𝑖𝑠𝑘 𝑃𝑟𝑒𝑚𝑖𝑢𝑚 = 11% + 5%

𝑴𝒂𝒓𝒌𝒆𝒕 𝑹𝒊𝒔𝒌 𝑷𝒓𝒆𝒎𝒊𝒖𝒎 = 𝟔%

New Portfolio Beta

Stock Amount Weighted Beta New Portfolio Beta

a b c = b / Total Amount d e=cxd
A P1,075,000 (1.75M / 3M) = 43/120 1.20 0.43
B 675,000 (675K / 3M) = 9/40 0.50 0.1125
C 750,000 (750K / 3M) = 1/4 1.40 0.35
D 500,000 (500K / 3M) = 1/6 0.75 0.125
P3,000,000 New Portfolio Beta = 1.0175

𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 ′ 𝑠 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 𝑟𝑅𝐹 + (𝑏)(𝑅𝑃𝑀 )

𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 ′ 𝑠 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 5% + (1.0175)(6%)

𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 ′ 𝑠 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 5% + 6.105

𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 ′ 𝑠 𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛 = 11.105

𝑷𝒐𝒓𝒕𝒇𝒐𝒍𝒊𝒐′ 𝒔 𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝑹𝒆𝒕𝒖𝒓𝒏 = 𝟏𝟏. 𝟏𝟏