Consider the following information and then calculate the required rate of return for the Global Investment Fund, which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows:
A) 9.58%
B) 10.09%
C) 10.62%
D) 11.18%
E) 11.77%

Question

Quizplus · Accepted Answer

The required rate of return can be calculated using the Capital Asset Pricing Model (CAPM): Required Rate of Return = Risk-Free Rate + Beta x (Market Return - Risk-Free Rate). However, the beta for each stock is not given, so we cannot use this formula directly. Instead, we can use the weighted average of the expected returns for each stock based on their percentage of the Fund's assets.

The weights for each stock are not given, but we can calculate them using the percentage of the Fund's total assets invested in each stock. Let's call these weights W. W1 = 20%, W2 = 30%, W3 = 25%, and W4 = 25%.

Using these weights, we can calculate the expected return for the Fund: 
Expected Return = W1 x Expected Return 1 + W2 x Expected Return 2 + W3 x Expected Return 3 + W4 x Expected Return 4

Plugging in the numbers, we get: 
Expected Return = 0.20 x 0.10 + 0.30 x 0.08 + 0.25 x 0.12 + 0.25 x 0.15 
Expected Return = 0.101 or 10.1%

Since the Fund's expected return is less than the market's required rate of return of 13.25%, we can conclude that the Fund is not adequately compensating investors for the risk they are taking. To make up for this, the required rate of return for the Fund must be higher than the expected return. We can use the following formula to calculate the required rate of return: 
Required Rate of Return = Risk-Free Rate + Beta x (Market Return - Risk-Free Rate)

Assuming a beta of 1 (average level of risk), the required rate of return would be: 
Required Rate of Return = 7% + 1 x (13.25% - 7%) 
Required Rate of Return = 11.25%

Since the market's required rate of return is 13.25%, the Fund should aim for a required rate of return higher than 11.25%. Based on the answer choices provided, the best choice is E) 11.77%.

Consider the Following Information and Then Calculate the Required Rate