B-4 (10 Marks)

Please consider each of the following parts independently.

Part 1 (3 marks)

The Money Tree Investment Fund has a total investment of $450 million in five stocks:

Stock Investment ($ Millions) Beta

1 130 0.4x

2 110 1.5x

3 70 3.0x

4 90 2.0x

5 50 1.0x

Required

a) What is the fund's overall Beta?

b) If the required return on the portfolio is 20.76% and the return on the market is 18%, what must be the risk-free rate?

Part 2 (4 marks)

The Money Tree Investment Fund is considering adding a new $30 million investment, White Inc. shares, to the list in Part 1. White Inc. has just paid a dividend, D0, of $1.50 per share, with an expected constant growth rate of 2%. Currently the market price is $88.00 per share. The firm's stock is twice as volatile as the market. The average market return is 8% and the yield on government securities is 3%. What is your recommendation? (Show supporting calculations.)

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Question # B-4 continued

Part 3 (3 marks)

A portfolio contains two assets. The first asset comprises 40 percent of the

portfolio and has a standard deviation of 0.1, and the other asset has a standard

deviation of 0.5.

If the correlation coefficient between the two assets is 0.2, what

is the portfolio's standard deviation?

What recommendation would you give a risk averse investor if the expected return on the portfolio is 12%? (Explain your answer.)