In structor s Ma nual Chapter 12 Page 145

a. Perform the calculations to verify that the expected returns of each of the portfolios (F, G, H, J, S) in the table (column 4) are

correct.

b. Do the same for the standard deviations in column 5 of the table.

c. Assume that you have $1million to invest. Allocate the money as indicated in the table for each of the five portfolios and

calculate the expected dollar return of each of the portfolios.

d. Which of the portfolios would someone who is extremely risk tolerant be most likely to select?

SOLUTION:

d. An extremely risk tolera nt pers on would select portfolio S, which has the largest sta ndard deviati on but also the largest expected retur

n.

3. A mutual fund company offers a safe money market fund whose current rate is

4.50% (.045). The same company also offers an equity fund with an aggressive growth objective which historically has exhibited an expected return of 20% (.20) and a standard deviation of .2

5.

a. Derive the equation for the risk-reward trade-off line.

b. How much extra expected return would be available to an investor for each unit of extra risk that she bears?

c. What allocation should be placed in the money market fund if an investor desires an expected return of 15% (.15)?

SOLUTION:

a. E[r] = .045 + .62 :二

b. 0.62

c. 32.3% [.15 = w*(.045) + (1-w)*(.020)]

4. If the risk-reward trade-off line for a riskless asset and a risky asset results in a negative slope, what does that imply about the risky asset vis-a-vis the riskless asset?

SOLUTION:

rewarded with less expected return for tak ing A trade-off line wit h a negative slope indicates that the investor is additional risk via

allocation to the risky asset.