Problem
You are currently invested in the Farrallon Fund, a broad-based fund of stocks and other securities with an expected return of 8% and a volatility of 33%. Currently, the risk-free rate is 2%. Your broker suggests that you add a new VC fund to your current portfolio. The VC fund has an expected return of 21% and a volatility of 76%. It has a correlation of 0.19 with the Farrallon Fund. Should you add the VC fund to your portfolio? Explain. (Hint: Assume that the fund is the "market" portfolio).
Here are the steps you need to take:
1) What is the beta of the VC fund with respect to the Farralon fund?
2) Given the beta, what return should you expect to get on the VC fund assuming the CAPM holds?
3) What return do you expect to get? Is this return better than the beta-based return?