Problem: Security Market Line
You plan to invest in Kish Hedge fund, which has total capital of $500 million invested in 5 stocks:
Sock Investment Stock's Beta coefficient
A $160 million 0.5
B $120 million 1.2
C $80 million 1.8
D $80 million 1.0
E $60 million 1.6
Kish's beta coefficient can be found as a weighted average of its stocks' betas. The risk free rate is 6%, and you believe the following probability distribution for future market returns is realistic:
Probability Market Return
0.1 -28%
0.2 0
0.4 12%
0.2 30%
0.1 50%
Q1. What is the equation for Security Market Line (SML)? (Hint : First determine the expected market return)
Q2. Calculate Kish's required rate of return.
Q3. Suppose Rick Fish, 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 15%, and its estimated beta is 1.5. should Kish invest in the new company? At what expected rate of return should Kish be indifferent to purchasing the stock?