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Minoru Asset Management is an Osaka-based asset management company with a mean- variance preference. It fully invests in the Nikkei index, the large-cap index for Tokyo Stock Exchange stocks. Nikkei has an expected return of 9.88% and standard deviation of 27.82%. Minoru is considering adding the Hang Seng index, the stock market index of Hong Kong, into their portfolio. Hang Seng has an expected return of 6.14%, a standard deviation of 19.84%, and a correlation of 0.55 with Nikkei. Suppose the risk-free rate in Japan is 3.3%.
1. Suppose Minoru is interested in improving the Sharpe ratio of the portfolio. Find the investment hurdle rate for Hang Seng. Will Minoru invest a positive amount in Hang Seng?
2. Suppose Minoru invests 90% in Nikkei and 10% in Hang Seng. What is the Sharpe ratio of the 90/10 portfolio? Is it better than that of Nikkei?
3. Assume the Fama-French two-factor model holds. Regressing the 90/10 portfolio return on the world market return and the global HML factor gives betas of 1.1 and -0.5, respectively. Assume that the world equity premium is 6% and the HML premium is 3%. Find the required return and alpha of the 90/10 portfolio using the Fama-French two-factor model.
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