7. Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. You now receive another $8.50 million, which you invest in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.) A) 8.57% B) 9.00% C) 7.80% D) 8.14% E) 7.97%

The correct answer is option (A).

Explanation:

According to the scenario, the computation of the given data are as follows:

First, we will calculate the Market risk premium, then

Market risk premium = (Required return - Risk free rate) : beta

= (9.50% - 4.20%) : 1.05 = 5.048%

So, now Required rate of return for new portfolio = Risk free rate + Beta of new portfolio * Market premium risk

Where, Beta of new portfolio = (10 : 18.5) * 1.05 + (8.5 : 18.5) * 0.65

= 0.5676 + 0.2986

= 0.8662

By putting the value, we get

Required rate of return = 4.20% + 0.8662 * 5.048%

= 8.57%