1 The security market line (SML) The Mitchell Investment Fund has total capital of 400 million. It is currently invested in five stocks: Stock Investment Beta (mil ) i A 120 0.5 B 100 2.0 C 60 4.0 D 80 1.0 E 40 3.0 a) Calculate the beta coefficient of the fund Fund. b) Risk-free rate is now 7 per cent (Rf = 7 %), and expected market return is 12 per cent (RM =12 %). Calculate the expected return of the fund kFund. c) Draw the security market line (SML) of the fund portfolio. d) Now suppose that another 50 mil. have been invested into the fund. John Mitchell president of the fund - receives an offer to invest this money in a new stock G. John Mitchell was told, that the stock has return 16 per cent p.a. (kG=16 %), and risk G = 2.5. Should the new stock be purchased? e) At what expected rate of return should Mitchell agree to purchasing the stock G? f) Assume that the fund manager decides to invest 50 mil. into another asset H instead of G. This asset H has risk H = 2.5 and return kH = 19.5 per cent p.a. - Will this investment have an impact on the risk of the fund portfolio Fund? - Will it modify the expected return of this portfolio kFund ? - How will the SML of the portfolio be modified? 2. Beta coefficient estimation You have obtained the last five years data about market performance (RM), about risk-less rate (RF) and about performance of the stock J (RJ) in which you are potentially interested. You want to decide, whether stock J fits your investment objectives. To estimate the future performance of stock J you need to calculate the beta coefficient of this stock J from the information provided. a) Draw the characteristic line of stock J using Microsoft Excel b) Estimate the beta coefficient of stock J. Year Market Stock J Risk-free rate RM (%) RJ (%) RF (%) 1 23.8 38.6 6.0 2 -7.2 -24.7 3.5 3 6.6 12.3 4.2 4 20.5 8.2 4.3 5 30.6 40.1 5.9