Corporate Investment Analysis - in FINANCE. Reilly, F., & Brown, K. (2012). Investment analysis and portfolio management (10th ed.). Mason, OH: South-Western/ Cengage Learning. Book used by Strayer University.
Question 1: As an equity analyst, you have developed the following return forecasts and risk estimates for two different stock mutual funds (Fund T and Fund U):
Forecasted CAPM
Return Beta
Fund T 9.0 1.20
Fund U 10.0 .80
A) If the risk-free rate is 3.9% and the expected market risk premium (i.e., E(RM) – RFR) is 6.1%, calculate the expected return for each mutual fund according to the CAPM.
B) Using the estimated expected returns for Part a along with your own return forecasts, demonstrate whether Fund T and Fund U are currently priced to fall directly on the security market line (SML), above the SML, or below the SML.
C) According to your analysis, the Funds T and U overvalued, undervalued, or properly valued?
Question 2: Draw the security market line for each of the following conditions:
a). (1) RFR = 0.08; RM(proxy) = 0.12
(2) Rz = 0.06; RM(true) = 0.15
b). Rader Tire has the following results for the last six periods. Calculate and compare the betas using each index.
RATES OF RETURN
Period Rader Tire
(%) Proxy Specific Index (%) True General Index (%)
1 29 12 15
2 12 10 13
3 -12 -9 -8
4 17 14 18
5 20 25 28
6 -5 -10 0
c). If the current period return for the market is 12% and for Rader Tire it is 11%, are superior results being obtained for either index beta?