Question no 1:

(a) FV 10 = 270
365∗10
(b) FV 10 = 100 * (1+ 0.1 ) = 271.79
365
I would prefer investment (b) due to higher future value in 10 years.

Question no 2:
(a) FV 5, Asset A = 100,000 * (1+10%)*(1+2%)*(1+5%)*(1+10%)*(1+12%) = 145,141.92
FV 5, Asset B = 100,000 * (1+6%)*(1+7%)*(1+5%)*(1+3%)*(1+6%) = 130,023.55
(b) Single annual rate Asset A
1
= [(1+10 )∗(1+2 )∗(1+5 )∗(1+10 )∗(1+12 )] 5 – 1 = 7.74%
Single annualrate Asset B
1
= [(1+6 )∗(1+7 )∗(1+5 )∗( 1+ 3 )∗(1+ 6 )] 5 – 1 = 5.39%

Question no 3:

Correlation at +0.25:

(a) i. E( R p ) = 100%*0.15 + 0%*0.35 = 0.15

σ 2p = 100 2 * 0.22 + 0 2 * 0.4 2 + 2*100%*0%*0.25*0.2*0.4 = 0.04
σ p = √ 0.04 = 0.2
ii. E( R p ) = 75%*0.15 + 25%*0.35 = 0.2

σ 2p = 75 2 * 0.22 + 25 2 * 0.4 2 + 2*75%*25%*0.25*0.2*0.4 = 0.04

σ p = √ 0.04 = 0.2

iii. E( R p ) = 50%*0.15 + 50%*0.35 = 0.25

2
σ p = 50 2 * 0.22 + 50 2 * 0.4 2 + 2*50%*50%*0.25*0.2*0.4 = 0.06
σ p = √ 0.06 = 0.24

iv. E( R p ) = 25%*0.15 + 75%*0.35 = 0.3

σ 2p = 25 2 * 0.22 + 75 2 * 0.4 2 + 2*25%*75%*0.25*0.2*0.4 = 0.1
σ p = √ 0.1 = 0.32

v. E( R p ) = 0%*0.15 + 100%*0.35 = 0.35

2
σ p = 0 2 * 0.22 + 100 2 * 0.4 2 + 2*0%*100%*0.25*0.2*0.4 = 0.16
σ p = √ 0.16 = 0.4
(b)

(c) i. E( R p ) = (-0.1)*0.15 + 1.1*0.35 = 0.37

σ 2p = (−0.1)2 * 0.22 + 1.12 * 0.4 2 + 2*(-0.1)*1.1*0.25*0.2*0.4 = 0.19
σ p = √ 0.19 = 0.44
ii. E( R p ) = (-0.5)*0.15 + 1.5*0.35 = 0.45

σ 2p = (−0.5)2 * 0.22 + 1.52 * 0.4 2 + 2*(-0.5)*1.5*0.25*0.2*0.4 = 0.34

σ p = √ 0.3 4 = 0.58

iii. E( R p ) = 1.5*0.15 + (-0.5)*0.35 = 0.05

σ 2p = 1.52 * 0.22 + (−0.5)2 * 0.4 2 + 2*1.5*(-0.5)*0.25*0.2*0.4 = 0.10
σ p = √ 0.10 = 0.32

(d)

(e) An investor who likes high mean and low standard deviation might hold the portfolio with 0.5 in
A and 0.5 in B given that it has relatively low standard deviation at 0.24 but generates a return of
0.25.
Correlation at 0:

I would still believe the same investor might hold the portfolio with 0.5 in A and 0.5 in B given that it has
relatively low standard deviation at 0.22 but generates a return of 0.25.

Question no 4:
(a) E( R p ) = 0%*0.16 + 100%*0.08 = 0.08
σ 2p = 0 2 * 0.12 + 100 2 * 02 + 2*0%*100%*0*0.1*0 = 0
σ p = √0 = 0
(b) E( R p ) = 50%*0.16 + 50%*0.08 = 0.12
2
σ p = 50 2 * 0.12 + 50 2 * 02 + 2*50%*50%*0*0.1*0 = 0.0025
σ p = √ 0 .0025 = 0.05
(c) E( R p ) = 1.25*0.16 + (-0.25)*0.08 = 0.18
σ 2p = 1.252 * 0.12 + (−0.25)2 * 02 + 2*1.25*(-0.25)*0*0.1*0 = 0.015625
σ p = √ 0.015625 = 0.125
2
(d) In this case, σ p = 0.1*2 = 0.2, so σ p = 0 .22 = 0.04
2
0.04 = w Fund * 0.12 , so w Fund = 2, and wf = 1 – 2 = -1
E( R p ) = 2*0.16 + (-1)*0.08 = 0.24

(e) An investor is facing the choices along the Capital Allocation Line (CAL) with the proportion to be
invested in risk-free versus risky assets. It is a reflection of risk/return tradeoff and the investor’s
level of risk aversion will affect allocations between risky and risk free assets. For instance, if the
investor has high risk aversion, he might choose the combination more towards the 100% risk-
free asset.