Assume that you are the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks. The required rate of return on the market is 11.00% and the risk-free rate is 5.00%. What rate of return should investors expect (and require) on this fund?

Stock Amount Beta

A $1,075,000 1.20

B 675,000 0.50

C 750,000 1.40

D 500,000 0.75

$3,000,000

11.11%

Explanation:

In this question, we apply the Capital Asset Pricing Model (CAPM) formula which is shown below for computing the rate of return

Expected rate of return = Risk-free rate of return + Beta * (Market rate of return - Risk-free rate of return)

For Stock A

= 5% + 1.20 * (11% - 5%)

= 5% + 1.20 * 6%

= 5% + 7.2%

= 12.2%

For Stock B

= 5% + 0.5 * (11% - 5%)

= 5% + 0.5 * 6%

= 5% + 3%

= 8%

For Stock C

= 5% + 1.40 * (11% - 5%)

= 5% + 1.40 * 6%

= 5% + 8.4%

= 13.4%

For Stock D

= 5% + 0.75 * (11% - 5%)

= 5% + 0.75 * 6%

= 5% + 4.5%

= 9.5%

Now the rate of return would be

= (Stock A amount * expected return + Stock B amount * expected return + Stock C amount * expected return + Stock D amount * expected return) : (Total amount)

= ($1,075,000 * 12.20% + $675,000 * 8% + $750,000 * 13.40% + $500,000 * 9.50%) : ($3,000,000)

= ($131,150 + $54,000 + $100,500 + $47,500) : ($3,000,000)

= 11.11%