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    Corporate Investment Analysis

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    8). As an equity analyst, you have developed the following return forecasts and risk estimates for two different stock mutual funds (Fund T and Fund U):

    Forecasted
    Return CAPM
    Beta
    Fund T 9.0 1.20
    Fund U 10.0 .80

    a). If the risk-free rate is 3.9% and the expected market risk premium (i.e., E(RM) - RFR) is 6.1%, calculate the expected return for each mutual fund according to the CAPM.

    b). Using the estimated expected returns for Part a along with your own return forecasts, demonstrate whether Fund T and Fund U are currently priced to fall directly on the security market line (SML), above the SML, or below the SML.

    c). According to your analysis, the Funds T and U overvalued, undervalued, or properly valued?

    10). Draw the security market line for each of the following conditions:
    a). (1) RFR = 0.08; RM(proxy) = 0.12
    (2) Rz = 0.06; RM(true) = 0.15

    b. Rader Tire has the following results for the last six periods. Calculate and compare the betas using each index.
    RATES OF RETURN
    Period Rader Tire
    (%) Proxy Specific Index (%) True General Index (%)
    1 29 12 15
    2 12 10 13
    3 -12 -9 -8
    4 17 14 18
    5 20 25 28
    6 -5 -10 0

    c). If the current period return for the market is 12% and for Rader Tire it is 11%, are superior results being obtained for either index beta?

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    Solution Summary

    8). As an equity analyst, you have developed the following return forecasts and risk estimates for two different stock mutual funds (Fund T and Fund U):

    Forecasted
    Return CAPM
    Beta
    Fund T 9.0 1.20
    Fund U 10.0 .80

    a). If the risk-free rate is 3.9% and the expected market risk premium (i.e., E(RM) - RFR) is 6.1%, calculate the expected return for each mutual fund according to the CAPM.

    b). Using the estimated expected returns for Part a along with your own return forecasts, demonstrate whether Fund T and Fund U are currently priced to fall directly on the security market line (SML), above the SML, or below the SML.

    c). According to your analysis, the Funds T and U overvalued, undervalued, or properly valued?

    10). Draw the security market line for each of the following conditions:
    a). (1) RFR = 0.08; RM(proxy) = 0.12
    (2) Rz = 0.06; RM(true) = 0.15

    b. Rader Tire has the following results for the last six periods. Calculate and compare the betas using each index.
    RATES OF RETURN
    Period Rader Tire
    (%) Proxy Specific Index (%) True General Index (%)
    1 29 12 15
    2 12 10 13
    3 -12 -9 -8
    4 17 14 18
    5 20 25 28
    6 -5 -10 0

    c). If the current period return for the market is 12% and for Rader Tire it is 11%, are superior results being obtained for either index beta?

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