SECURITY MARKET LINE

You plan to invest in the Kish Hedge Fund, which has total capital of $500 million invested in five stocks:

Stock Investment Stock's Beta Coefficient

A 160 million 0.8

B 120 million 1.8

C 80 million 4.1

D 80 million 1.0

E 60 million 3.6

Kish's beta coefficient can be found as a weighted average of its stocks' betas. The risk-free rate is 4%, and you believe the following probability distribution for future market returns is realistic:

Probability Market Return

0.1 (7%)

0.2 9

0.4 12

0.2 13

0.1 17

A.) What is the equation for the Security Market Line (SML)? (Hint: First determine the expected market return.)

1. ri= 3.6% + (7.4%)bi
2. ri= 4.0% + (6.3%)bi
3. ri= 3.4% + (6.2%)bi
4. ri= 3.4% + (6.3%)bi
5. ri= 4.0% + (6.2%)bi

B.) Calculate Kish's required rate of return. Do not round intermediate calculations. Round your answer to two decimal places.

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C.) Suppose Rick Kish, the president, receives a proposal from a company seeking new capital. The amount needed to take a position in the stock is $50 million, it has an expected return of 14%, and its estimated beta is 1.4. Should Kish invest in the new company?

The new stock-Select-should not should not be purchased.

At what expected rate of return should Kish be indifferent to purchasing the stock? Round your answer to two decimal places.

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