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?
See the attached file.
Expected return = Rf + Beta1(Rm - Rf) + Beta2(RGNP - Rf) + Beta3(Rinf - Rf)
Rf = 0.03
Beta Risk premium
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.