QUESTION 2

Innis Investments manages funds for a number of companies and wealthy clients. The
investment strategy is tailored to each client’s needs. For a new client, Innis has been
authorized to invest up to RM1.2 million in two investment funds: a stock fund and a money
market fund. Each unit of the stock fund costs RM50 and provides an annual rate of return of
5%; each unit of the money market fund costs RM100 and provides an annual rate of return
of 4%.

The client wants to minimize risk subject to the requirement that the annual income from the
investment be at least RM60,000. According to Innis’s risk measurement system, each unit
invested in the stock fund has a risk index of 8, and each unit invested in the money market
fund has a risk index of 3; the higher risk index associated with the stock fund simply indicates
that it is the riskier investment. Innis’s client has also specified that at least RM300,000 be
invested in the money market fund.

In her investment plan, Innis has to follow the client request to minimize the total risk index for
the portfolio investment.

a) Let X1 = units purchased in the stock fund and X2 = units purchased in the money
market, formulate the LP Programming.

Minimize total risk index = 8X1 + 3X2

subject to 50X1 + 100X2 ≤ 1.2 million (investment)

5X1 + 4X2 ≥ 60,000 (annual income)
X2 ≥ 3,000 (money market investment)
X1, X2 ≥ 0

b) Solve the LP Programming problem using QM for Windows. What is the optimal solution,
and what is the minimum total risk?

Optimal solution is X1 = RM 4,000

X2 = RM 10,000

Thus the minimum total risk = 8X1 + 3X2

= RM 62,000

c) What is the rate of return for the portfolio?

Annual income from the investment
Rate of return = x 100
Investment
 60,000
= x 100
1,200,000

= 5%

d) What are the dual prices for the constraints? Interpret each.

The non-zero dual prices of 0.06 for constraint 1 (investment) and -2.17 for
constraint 2 (annual income) tells that
 An additional investment improves (increase) the value of the optimal
solution by RM0.06
 An increase in annual income will affect (decrease) the optimal value by
RM2.17

e) Suppose the risk index for the stock fund increases from its current value of 8 to 12.
Would the solution change? Justify you answer.

According to the above ranging, upper limit for stock fund is infinite, thus any
increase on the risk index will not affect the optimal solution.