Mr Lee manages a fund which consists of 3 investments, namely, A, B and C.

The information pertaining to the investments and the market are given below:

Investment               Amount                 Beta

Stock A                      $30,000                1.6

Stock B                      $50,000                1.2

Stock C                      $20,000               -0.2

Market risk premium = 6%

Risk-free rate = 3%

a) Compute the beta and expected return of Mr Lee’s fund.

b) Investors in Mr Lee’s fund have complained that the fund’s volatility is high. They are not comfortable with the relatively large fluctuations in the fund’s value. Ms Lim, the analyst, suggests that the fund sells some of the high beta stocks and invests the proceeds in bonds.

Discuss the impact on the beta of the fund and its expected return.

c) Mr Tan, another analyst in the fund, suggested that the fund’s volatility can be reduced by selling high beta stocks and investing in low beta stocks

Discuss one (1) reason why Ms Lim’s suggestion may be superior to Mr Tan’s. In other words, why is having some bonds in the portfolio better than an all-stock portfolio.

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