You are currently only invested in the
Natasha FundNatasha Fund
(aside from risk-free securities). It has an expected return of
13 %13%
with a volatility of
22 %22%.
Currently, the risk-free rate of interest is
3.7 %3.7%.
Your broker suggests that you add
HannahHannah
Corporation to your portfolio.
HannahHannah
Corporation has an expected return of
20 %20%,
a volatility of
58 %58%,
and a correlation of
00
(zero) with the
Natasha FundNatasha Fund.
a. Calculate the required return of
HannahHannah
stock. Is your broker right?
b. You follow your broker's advice and make a substantial investment in
HannahHannah
stock so that, considering only your risky investments,
61 %61%
is in the
Natasha FundNatasha Fund
and
39 %39%
is in
HannahHannah
stock. When you tell your finance professor about your investment, he says that you made a mistake and should reduce your investment in
HannahHannah.
Recalculate the required return on
HannahHannah
stock. Is your finance professor right?
c. You decide to follow your finance professor's advice and reduce your exposure to
HannahHannah.
Now
HannahHannah
represents
20.139 %20.139%
of your risky portfolio, with the rest in the
Natasha FundNatasha Fund.
Recalculate the required return on
HannahHannah
stock. Is this the correct amount of
HannahHannah
stock to hold?
d. Calculate the Sharpe ratio of each of the three portfolios. What portfolio weight in
HannahHannah
stock maximizes the Sharpe ratio?