You plan to invest in a portfolio fund. The fund’s total capital is $150 million, which is invested into stock FIB ($60 million) and stock ATM ($90 million). Stock FIB has a beta of 0.8 and stock ATM has a beta of 1.3. The following is probability distributions for the future possible returns of both stocks:

Probability Stock FIB Stock ATM

.3 2% -10%

.5 5% 16%

.2 14% 26%

Currently, the yield of treasury security is 2% and market risk premium is 4%.

a. Find the portfolio’s expected return

b. Find the portfolio’s beta and required return.

c. Identify whether the portfolio is undervalued, fair valued, or overvalued.

d. Explain market reaction and adjustment process in the market for this portfolio fund.

e. Draw the Security Market Line(SML), write the equation of the SML line, plot the portfolio’s required return and expected return, and indicate to which direction the expected return should move.