Question

Suppose that an investor is holding an equity portfolio that is worth $700,000 and has a...

Suppose that an investor is holding an equity portfolio that is worth $700,000 and has a beta of 1.4 from which the expected return is 12% per annum. The investor would like to purchase $500,000 of units in a hedge fund that has a beta of 0.6 from which a return of 4% per annum is expected. The total value of the new portfolio is __________. The weight in the hedge fund in the new portfolio is __________. The beta of the new portfolio is __________. The expected return of the new portfolio is __________. The addition of the hedge fund __________ (has or has not) improved the overall risk-return profile of the portfolio.

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Answer #1

The Total Value of the new Portfolio =700000+500000 =1,200,000
Weight of hedge funds =Value of Hedge funds/(Value of equity Portfolio+Value of hedge funds) =500000/1200000=41.67%
Beta of New Portfolio =Weight of Hedge Funds*Beta of Hedge funds+(1-Weight of Hedge funds)*Beta of Equity
=41.67%*0.6+(1-41.67%)*1.4 =1.07
Expected Return of the new portfolio =Weight of Hedge Funds*Return of Hedge funds+(1-Weight of Hedge funds)*Return of Equity=41.67%*4%+(1-41.67%)*12% =8.67%
The addition of hedge funds has not improved the risk return profile of the portfolio

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