Investment Science

Chapter 7
Solutions to Suggested Problems
Dr. James A. Tzitzouris
<jimt2@ams.jhu.edu>

7.1

0.23−0.07 σ
(a) r̄ = 0.07 + 0.32 σ = 0.07 + 2

(b) i. σ = 0.64, ii. Solve 0.07w + 0.23(1 − w) = 0.39, yielding w = −1. Hence, borrow $1000 at the
risk-free rate; invest $2000 in the market.

(c) $1182

7.2

(a)

2 1 2 2
σM = (σ + 2σAB + σB ),
4 A
2 1 2
σAM = (σ + σAB ),
2 A
2 1 2
σAB = (σAB + σB ),
2
σA2 +σ
AB
βA = 2 ,
σM
2 +σ
σB AB
βB = 2 .
σM

1
(b)
5
r̄A = 0.1 + (0.18 − 0.1) = 20%,
4
3
r̄B = 0.1 + (0.18 − 0.1) = 16%.
4

7.3

(a) Using the two-fund theorem and noting that the market portfolio cannot contain assets in
negative amounts, we have
1 1
T
w+ v = 0.7 0 0.3 with a return of 0.1,
2 2

T
2w − v = 0.4 0.6 0 with a return of 0.16,

so the expected rate of return of the market portfolio r̄M is bounded as follows: 0.1 ≤ r̄M ≤ 0.16.

(b) Since r̄M ≥ r̄min var portfolio , we have 0.12 < r̄M ≤ 0.16.

7.4

From (6.9) we have

n
X
2
σM i λwi = λσM = r̄M − rf .
i=1

Hence,
r̄M − rf
λ = 2 .
σM

Furthermore,
n
X
σki λwi = λσkM = r̄k − rf .
i=1

Substituting the expression for λ into the above equation, we arrive at our objective.

2
7.5

We have
σiM xi σi2
βi = 2 = Pn 2
σM j=1 xj σj

for all i = 1, . . . , n, since the assets are uncorrelated.

7.6

The market consists of $150 in shares of A and $300 in shares of B. Hence, the market return is
1 2
rM = (150/450)rA + (300/450)rB = rA + rB .
3 3

(a) 0.13

(b) 0.09

(c) σAM = 31 σA
2 + 2ρ
3 AB σA σB = 0.0105, βA = 1.2963

(d) Since Simpleland satisfies the CAPM exactly, stocks A and B plot on the security market line.
Specifically, r̄A − rf = βA (r̄M − rf ). Hence, rf = 0.0625.

7.7

(a) Let p be a portfolio such that p = (1−α)w0 +αw1 . Then, σp2 = (1−α)2 σ02 +2(1−α)ασ01 +α2 σ12 .
dσ 2 

So, since 0 = dαp  , we have 0 = −2σ02 + 2σ01 which implies that A = 1.
α=0
 2 
σ0
(b) 0 = σ1z = (1 − α)σ01 + ασ12 implies (using (a)), α = σ2 −σ 2 < 0.
0 1

(c) The zero-beta portfolio is on the minimum variance set but below the minimum variance point.

σiM ρσi
(d) ρ = σi σM =⇒ r̄i = r̄z + σM (r̄M − r̄z ) = 0.09 + (0.5)(0.5/0.15)(0.15 − 0.09) That is, r̄i = 10%.