PROBLEM 8-17

PORTFOLIO BETA: Suppose you are a manager of a mutual fund and hold a $10
million portfolio with a beta of 1.3. The required market risk premium is 7% and the risk
free is 4%. You expect to invest an additional fund of $5 million, in a number of stocks
and the final required return of the aggregated is expected to be 16%. What should the
average beta of the new stocks added to the portfolio?
ANSWER: X = 2.544
FORMULA:
After additional investments are made, for the entire fund to have an expected return of
16%, the portfolio must have a beta of 1.7143 as shown below:
GIVEN:
Risk premium = 7%
Risk-free = 4%
Final required return of the aggregated is expected to be = 16%
16%= 4% + (7%) b
BETA = 1.7143

Since the fund’s beta is a weighted average of the betas of all the individual investments,
we can calculate the required beta on the additional investment as follows:
GIVEN:
Portfolio = $10 million
Beta of $10 million = 1.3
Expected investment in additional fund = $5 million
FORMULA:
$10 Million + $5 Million = $15 Million

$10,000,000(1.3) $5,000,000 X
1.7143 = +
$15,000,000 $15,000,000
1.7143 = 0.867 + 0.333X
0.8473 = 0.333X
X = 2.544