Question

You are currently only invested in the Natasha Fund​ (aside from​ risk-free securities). It has an expected return of 14 % with a volatility of 20 %. ​Currently, the​ risk-free rate of interest is 3.8 %. Your broker suggests that you add Hannah Corporation to your portfolio. Hannah Corporation has an expected return of 20 %​, a volatility of 60 %​, and a correlation of 0​ (zero) with the Natasha Fund. a. Calculate the required return of Hannah stock. Is your broker​ right? b. You follow your​ broker's advice and make a substantial investment in Hannah stock so​ that, considering only your risky​ investments, 60 % is in the Natasha Fund and 40 % is in Hannah stock. When you tell your finance professor about your​ investment, he says that you made a mistake and should reduce your investment in Hannah. Recalculate the required return on Hannah stock. Is your finance professor​ right? c. You decide to follow your finance​ professor's advice and reduce your exposure to Hannah. Now Hannah represents 15.000 % of your risky​ portfolio, with the rest in the Natasha fund. Recalculate the required return on Hannah stock. Is this the correct amount of Hannah stock to​ hold? Hint​: Make sure to round all intermediate calculations to at least five decimal places. a. Calculate the required return of Hannah stock. The required return of Hannah stock is

Answer 1

a).

Natasha Hannah

Required Rate of return 14% 20%

Risk free rate 3.8% 3.8%

Volatility 20% 60%

No, since the required rate of return is more than the expected rate of return

b).

Yes

c).

Yes, since, at this rate the average beta works out to 1