John Davidson is an investment adviser at Leeds Asset Management plc. He is asked by a client to evaluate various investment opportunities currently available and he has calculated expected returns and standard deviations for five different well-diversified portfolios of risky assets: Portfolio Expected return Standard deviation Q 7.8% 10.5% R 10.0% 14.0% S 4.6% 5.0% T 11.7% 18.5% U 6.2% 7.5% (a) For each portfolio, calculate the risk premium per unit of risk (Sharpe ratio) that you expect to receive. Assume that the risk-free rate is 3.0%. (b) Using answers from a, which of these five portfolios is most likely to be the market portfolio and explain why. (200 words maximum) (c) If you are only willing to make an investment with a standard deviation of 7.0%, is it possible for you to earn a return of 7.0%? (d) What is the minimum level of risk that would be necessary for an investment to earn 7.0%? What is the composition of the portfolio along the Capital Market Line (CML) that will generate that expected return?
John Davidson is an investment adviser at Leeds Asset Management plc. He is asked by a client to evaluate various investment opportunities currently available and he has calculated expected returns and standard deviations for five different well-diversified portfolios of risky assets:
|
Portfolio |
Expected return |
Standard deviation |
|
Q |
7.8% |
10.5% |
|
R |
10.0% |
14.0% |
|
S |
4.6% |
5.0% |
|
T |
11.7% |
18.5% |
|
U |
6.2% |
7.5% |
(a) For each portfolio, calculate the risk premium per unit of risk (Sharpe ratio) that you expect to receive. Assume that the risk-free rate is 3.0%.
(b) Using answers from a, which of these five portfolios is most likely to be the market portfolio and explain why. (200 words maximum)
(c) If you are only willing to make an investment with a standard deviation of 7.0%, is it possible for you to earn a return of 7.0%?
(d) What is the minimum level of risk that would be necessary for an investment to earn 7.0%? What is the composition of the portfolio along the Capital Market Line (CML) that will generate that expected return?
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