The Franklin MicroCap Value ADV Fund sells at at $36 per share, and has a 3-year

Question

The Franklin MicroCap Value ADV Fund sells at at $36 per share, and has a 3-year average annual return of $3 per share.

The risk measure of standard deviation is 17.1.

The deleware Select Growth Fund sells at $46 a share and has a 3-year average annual return of $8 a share.

The risk measure of standard deviation is 15.5.

Sally Burkhardt wants to spend no more than $8000 investing in these two funds, but she wants to obtain at least $800 in annual revenue.

Sally also wants to minimize her risk. Determine how many shares of each stock Sally should buy.

(Mathematics with Applications in the Management, Natural, and Social Sciences, 11th edition.) (7.3; Question 25)

Explanation / Answer

We need to know the covariance in the returns of both the stocks i.e how the prices of these stocks are correlated.

Return on Microcap value ADV fund = 3 / 36 = 8.333%

Return on Delaware select growth fund = 8 / 46 = 17.39%

Also,

risk on Microcap ADV = 17.1

rsik on Delaware Growth = 15.5

Thus, delaware growth fund provides both, a higher return and a lower risk as compared to Microcap ADV fund.

Thus, entire money has to be invested in Delaware growth fund so as to minimize risk.

Note: The correlation between the share prices is not given in the problem. A negative correlation between the shares can result into a lower risk than the one currently being taken by Sally. I hope that information has not been missed out by mistake else the answer to this problem would change.

Hope this helps.

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