Portfolio Amount 300000 Weight E(X) Volatility

Amount in RFA 90000 30% 2.50% 0%

Risky asset 210000 70% 12.50% 25%

Return on RFA 2.50%

Expected return portfolio 12.50%
Volatility of P 25%

Portfolio E(X) 9.50%

Volatility 17.50%

Sharpe 40.00%
m (intercept) 2.50%

VOL
How to make grpah X values Y Values
0% 2.50%
2% 3.30%
4% 4.10% Y Values
6% 4.90% 16.00%
8% 5.70%
14.00%
10% 6.50%
12.00%
12% 7.30%
14% 8.10% 10.00%
16% 8.90% 8.00%
E(X)

18% 9.70%
6.00%
20% 10.50%
4.00%
22% 11.30%
24% 12.10% 2.00%
26% 12.90% 0.00%
0% 2% 4% 6% 8% 10% 12% 1
28% 13.70%

Exercise E(X) Volaility

Rf 7.00%
E(Rp) 12.50%
Volatility 25.00%

Sharpe 22.00%
0 0
2 10
X Y U with A 2 U10
0% 7.00% 8.30% 0
2% 7.44% 8.04% 0.01
4% 7.88% 8.16% 0.04
6% 8.32% 8.36% 0.09
8% 8.76% 8.64% 0.16
10% 9.20% 9.00% 0.25
12% 9.64% 9.44% 0.36
14% 10.08% 9.96% 0.49
16% 10.52% 10.56% 0.64
18% 10.96% 11.24% 0.81
20% 11.40% 12.00% 1
22% 11.84% 12.84% 1.21
24% 12.28% 13.76% 1.44
26% 12.72% 14.76% 1.69
28% 13.16% 15.84% 1.96

Intercept 8.10% E®

Chart Title
2.5

1.5

0.5

0
0 2 4 6 8 10 12 14 16
 PP
- capital allocation line
(CAL) , shows allocation of risk free and risky asset

(E(X) is on y- axis
SD (volaitlity) is on x-axis

How to compute CAL Line

Formula
E(X) of complete portfolio
return of risk free asset + (1 + risk free premium)

Variance
- only dependent on risky asset

Sigma plane
Exercise:

SHARPE = (Return of risky asset - retrun of RFA ) / Volaitlity

- > sharpe is the gradient of the line

HOW TO FIND RISK AVERSION

U = utility function
U = E(r) - 0.5A variance of return s
A = Cofficient of risk aversion

Y Values
6.00%

4.00%

2.00%

0.00%
(average is amongst 2.5 to 5)
8.00% Utility score for portfolio
Need: [E(R) and sd, ask A (risk aversion)
6.00% = return in % - (A risk aversion * SD^2)
4.00% --> to plot utility curves with graph ( X-axis SD, ER is y axis )
-- > the higher the U curve the better (happy client)
2.00%

0.00% IDEA?
0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% 24% 26% 28% Fit CAL with Utility curve (intersection of the 2)
 0 A 2
8.1 U 8.30%
U at 8,1
CAL Utility
18.00%

16.00%

14.00%

12.00%

10.00%

8.00%

6.00%

4.00%

2.00%

0.00%
0 2 4 6 8 10 12 14 16

CAL & U10

80.00%

70.00%

60.00%

50.00%

40.00%

30.00%

20.00%

10.00%

0.00%
0% 5% 10% 15% 20% 25% 30%
n of risk free and risky asset

xis

ine

olio
t + (1 + risk free premium)

sky asset

sky asset - retrun of RFA ) / Volaitlity of risky asset

nt of the line

ERSION

of return s
ersion

5 to 5)
io
A (risk aversion)
version * SD^2)

s with graph ( X-axis SD, ER is y axis ) = SIGMA PLANE THING

urve the better (happy client)

ve (intersection of the 2)
 44% 12.50%
A 2 56% 7%
Compute W* (Erp - rf) /(A*sd^2)
44.00% Risky weight

Optimal Portfolio
E(X) 9.42%
Volaitility 11.00% X
0%
U* 8.21% 2%
4%
6%
Portolfio with A 10 8%
W* 8.80% 10%
12%
Optimal Portfolio 14%
E(X) 7.48% 16%
Volatitilyy 2.20% 18%
14 16
20%
22%
U* 7.24% 24%
26%
28%
 0 0
2 10
Y U with A 2 U10 50.00%
7.00% 9.42% 7.48% 45.00%
7.44% 9.46% 7.68% 40.00%
7.88% 9.58% 8.28% 35.00%
8.32% 9.78% 9.28% 30.00%
8.76% 10.06% 10.68%
25.00%
9.20% 10.42% 12.48%
20.00%
9.64% 10.86% 14.68%
15.00%
10.08% 11.38% 17.28%
10.00%
10.52% 11.98% 20.28%
5.00%
10.96% 12.66% 23.68%
11.40% 13.42% 27.48% 0.00%
0% 5% 10% 15% 20% 25%
11.84% 14.26% 31.68%
U with A 2 U10 CAL
12.28% 15.18% 36.28%
12.72% 16.18% 41.28%
13.16% 17.26% 46.68%
15% 20% 25% 30%

U10 CAL