Question
6. Suppose an endowment fund is currently investing 20% of its portfolio in a risk-free asset and investing the remaining 80% with a private equity
6. Suppose an endowment fund is currently investing 20% of its portfolio in a risk-free asset and investing the remaining 80% with a private equity fund, YZW LLC. The endowment fund analyzed holdings of YZW's portfolio and found that its expected returns over the next year will be 10%, with a standard deviation of 25%. Research conducted by the endowment fund indicates that the market portfolio will have expected return of 10% and standard deviation of 20% during the next year. The correlation of returns between YZW's portfolio and the market portfolio is 0.8. Suppose that the risk-free asset will yield 5% return over the next year. a Compute the CAPM beta of YZW's portfolio. b Compute the CAPM beta and alpha of the endowment fund's portfolio. c Suppose that you were retained as an advisor to the endowment fund. Would you recommend divesting part of the holdings in YZW and reallocating them to the market portfolio? (Hint: compare Sharpe ratios)
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