Posted: January 10th, 2017

- Two assets A and B are available for investment. Asset A has an expected return of 12 percent per annum and a standard deviation of 10 percent. Asset B has an expected return of 18 percent and a standard deviation of 20 percent. Assume two portfolios are being considered (i) comprised 25 percent of A and 75 percent in B, and, (ii) comprised 75 percent of A and 25 percent of B. The correlation coefficient between A and B is 0.6. (The variance of the two assets

portfolio is σ ^{2} |
= w ^{2}σ |
2 | + w ^{2}σ |
2 | + 2w w |
2 | ρ |
1, 2 | σ σ |
2 | ) | ||

p |
1 | 1 | 2 | 2 | 1 | 1 | |||||||

(a) | Calculate the rates of return and standard deviations for the above | [35] | |||||||||||

two portfolios, and draw an approximate diagram illustrating the | |||||||||||||

possible return and risk combinations (opportunity set). | |||||||||||||

(b) | What difference would the availability of a risk-free asset yielding 5 | [35] | |||||||||||

percent per annum make to the risk return frontier you have drawn | |||||||||||||

in (a) above? What are the benefits to investors of the risk free | |||||||||||||

asset. State all assumptions you make (supporting calculations are | |||||||||||||

not required). | |||||||||||||

(c) | Discuss the extension of the two asset portfolio to a many asset | [30] | |||||||||||

portfolio. What conclusions can be drawn? |

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