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1.

Expected return = (0.7 × 18%) + (0.3 × 8%) = 15% Standard deviation = 0.7 × 28% = 19.6%

2. Investment proportions: 0.7 × 25% = 0.7 × 32% = 0.7 × 43% = 30.0% in T-bills 17.5% in Stock A 22.4% in Stock B 30.1% in Stock C

4.

30 25 20 E(r) 15 % 10 5 0 0 10 20 30 40

CAL (Slope = 0.3571) P

Client

σ ( % )

7-1

203% 7-2 .0% in Stock A 25. E(rC) = rf + y[E(rP) – rf] = 8 + y(18 − 8) If the expected return for the portfolio is 16%.8 × 25% = 0.644% σC = 0.429 = 14.8 × 43% = c.8 × 32% = 0. Client’s investment proportions: 0.5 × 28 7.3644 × 28 = 10.6429 = 64. a.29% invested in the risky portfolio b. b.01 × 3.4% 6. E(rC) = 8 + 10y = 8 + (0.0% in T-bills 20. σ C 20.8 × σP = 0. b. a. a.44 0.56% invested in T-bills. E(rC) = 8 + 10y* = 8 + (0. σC = y × 28% If your client prefers a standard deviation of at most 18%.8 10 Therefore.429% E (rP ) − rf 18 − 8 10 = = = 0.8 × 28% = 22.4% in Stock C = 0.6429 × 10) = 8 + 6.6% in Stock B 34. in order to have a portfolio with expected rate of return equal to 16%. the client’s optimal proportions are: 36. y* = Therefore.5. then: y = 18/28 = 0.44% invested in the risky portfolio and 63. the client must invest 80% of total funds in the risky portfolio and 20% in T-bills.3644 2 2 27. then: 16 = 8 + 10 y ⇒y = 16 − 8 = 0.3644 × 10) = 11.01Aσ P 0.

2002 is assumed to be representative of future expected performance.22%. My fund allows an investor to achieve a higher mean for any given standard deviation than would a passive strategy. a. E(rM) − rf = 8.81% (we use the standard deviation of the risk premium from Table 7. Slope of the CML = 13 − 8 = 0. If the period 1926 .4).20 25 The diagram follows. CML and CAL 18 16 14 12 10 8 6 4 2 0 0 10 Standard Deviation 20 30 Expected Retrun CAL: Slope = 0.3571 CML: Slope = 0. Then y* is given by: 7-3 . a.8. i. a higher expected return for any given level of risk. σM = 20..20 11. then we use the following data to compute the fraction allocated to equity: A = 4.e. b.

45% of the portfolio should be allocated to equity and 52.01Aσ M 0.000 = $13.4 × 6%) = 12% Standard deviation of client’s overall portfolio = 0.5% 8−5 = 0.01 × 4 × 16.000)] − $5. E(rC) = 8% = 5% + y(11% – 5%) ⇒ y = σC = yσP = 0. 20. then we use the following data to compute the fraction allocated to equity: A = 4.000 21. c. c. c Expected return for equity fund = T-bill rate + risk premium = 6% + 10% = 16% Expected return of client’s overall portfolio = (0.7924 2 0.y* = E (rM ) − rf 8.50 × 15% = 7.2002 is assumed to be representative of future expected performance. If the period 1983 . 47. which explains the greater proportion invested in equity. a.6 × 14% = 8.812 That is.38%. b 22.76% should be allocated to T-bills. E(rM) − rf = 8. 79.4 × (− $30.01Aσ M 0.38 = = 0.55% should be allocated to T-bills.26% and y* is given by: y* = E (rM ) − rf 8.5 11 − 5 The first client is more risk averse.4% 7-4 . the reward-to-variability ratio is expected to be higher in part (b). the market risk premium is expected to be higher than in part (a) and market risk is lower. 13.000) + [0.4745 2 0.26 2 Therefore. σM = 16.22 = = 0. allowing a smaller standard deviation.6 × 16%) + (0. Therefore. In part (b).24% of the complete portfolio should be allocated to equity and 20.6 × $50. a (0. b. b.01 × 4 × 20.

7-5 .

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