You are currently only invested in the K Fund (aside from risk-free securities). The expected return for the K Fund is 13.50% with a volatility of 17.10%. Your broker suggests that you add Murni Berhad (MURNI) to your portfolio. With the volatility of 54%, MURNI has an expected return of 18.00%. There is a zero correlation between MURNI and K Fund. Currently, the Treasury Bill yields approximately 3.20%.
a) Show your working to prove whether your broker is right.
b) You follow your broker’s advice and make a substantial investment in MURNI stock so that, considering only your risky investments, 65% is in the K Fund and 35% is in MURNI stock. When you tell your finance lecturer about your investment, your lecturer says that you made a mistake and should reduce your investment in MURNI. Justify your opinion of whether your finance lecturer is right.
c) You decide to follow your finance lecturer’s advice and reduce your exposure to MURNI. Now MURNI represents 15% of your risky portfolio, with the rest in the K Fund. Decide and justify whether this is the correct amount of MURNI stock you should hold.
d) Calculate the Sharpe ratio of each of the three portfolios. Decide on the portfolio weight in MURNI stock that maximizes the Sharpe ratio.
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