Estimate expected returns, find the beta and return on fund

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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?

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Solution Preview

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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.

$2.49