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Estimate expected returns, find the beta and return on fund

Estimate expected returns and find the beta and the return on the fund.

1. You use a factor model to estimate expected returns on Daemon stock. The risk-free rate is 3%. You have the following information:
Factor Factor Beta Risk Premium
GNP .80 .49%
Inflation 1.20 -.83%
Market .45 6.36%

2. Honest Dave's Used Mutual Fund has a $200 million portfolio invested in the following stocks:
Stock Investment Beta
Fraud Motors 60M 0.5
BIM 50M 2.0
Motel Electronics 30M 4.0
Major Foods 40M 1.0
William Television Company 20M 3.0

a) The expected risk-free rate is 4% and the expected return on the market is 16%. Find the beta and the return on the fund.

b) Suppose management receives a proposal to purchase a new stock. The investment needed to take a position in the stock is 50 million; it will have an expected return of 18% and its estimated beta coefficient is 2.50. Should the stock be purchased? At what expected return would management be indifferent to purchasing the stock?

Solution Preview

See the attached file.

Solution 1

Expected return = Rf + Beta1(Rm - Rf) + Beta2(RGNP - Rf) + Beta3(Rinf - Rf)

Rf = 0.03
Beta Risk premium
0.8 0.0049
1.2 -0.0083
0.45 0.0636

threfore, ...

Solution Summary

The solution carefully presents the formulas and calculation to understand the answers to the problem. There is a short paragraph of narrative in response to part b.

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