You are told that the expected return of the market portfolio is 10%, and its standard deviation is 10%. There exists a risk-free asset in the economy. You hold an efficient portfolio with an expected return of 12% and a standard deviation of 15%. [hint: The efficient portfolio is a combination of the market portfolio and the risk-free asset.] (1) In forming this efficient portfolio do you borrow or lend? Support your answer with relevant calculations. (2) What is the risk-free rate?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
- You are told that the expected return of the market portfolio is 10%, and its standard deviation is 10%. There exists a risk-free asset in the economy. You hold an efficient portfolio with an expected return of 12% and a standard deviation of 15%. [hint: The efficient portfolio is a combination of the market portfolio and the risk-free asset.]
(1) In forming this efficient portfolio do you borrow or lend? Support your answer with relevant calculations.
(2) What is the risk-free rate?
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