Return of fund is independent of return of the market index

Assignment Help Financial Management

Reference no: EM131459148

An equity hedge fund manageer with an equity capital of $50 million sets his portfolio beta to zero in order to be market neutral. He retains a cash cushion of $2 million for unforseen situations (e.g. margin calls and redemption) and utilizes the rest of the equity capital in implementting market neutral strategy.

shares can be borrowed from a prime broker and the short margin ratio requirement m is set at 60% of short sales proceeds. Two mispriced stocks have been identified: A and B. At their current valuation, stock A is expected to yield 19.1% while stock B's expected return is 14.1%.

Suppose CAPM is the correct asset pricing model and the market index's expected return and risk free rate are 10% and 3% respectively. Stock A has a beta of 1.8 while that of stock B is 1.2.

The fund can earn an interest rate of 1% from its $2 million idle cash and the margin deposit with the prime broker. We assume that the hedge fund aims, as usual, to achieve the maximize degree of leverage possible.

Q) Please prove numerically that return of the fund is independent of the return of the market index, wheter ex-ante or ex-post.

Reference no: EM131459148

Questions Cloud

Cost of equity rises as the amount of debt increases : In each of the theories of capital structure the cost of equity rises as the amount of debt increases.

Management contract with its newly hired president : The Great Giant Corp. has a management contract with its newly hired president. How much must the company set aside each year for this purpose?

Hydras restaurant chain expansion plan : What cost of capital should be applied to Hydra's restaurant chain expansion plan?

What is the difference in the present value : What is the difference in the present value if you receive these payments at the beginning of each year rather than at the end of each year?

Return of fund is independent of return of the market index : Please prove numerically that return of the fund is independent of the return of the market index, wheter ex-ante or ex-post.

Discussed project constraints : In this chapter the authors discussed project constraints. They divided them into two categories, technical and resource. Describe each type of constraint.

What is the expected return of such strategy : How should the hedge fund execute its market neutral strategy and what is the expected return of such strategy?

What is the effective annual return : Maybepay Life Insurance Co. is selling a perpetual annuity contract that pays $3,400 monthly. What is the effective annual return?

Professional partnership such as small accounting firm : Succession planning is often overlooked with all that small business owner must do to be successful. professional partnership such as a small accounting firm.

User Account

All Pages