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Corporate Investment Analysis

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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