PORTFOLIO RISK AND RETURN: PART II

SOLUTIONS

1. B is right. The capital allocation line, CAL, is a mixture of the risk-free asset and a dangerous asset (or a portfolio of dangerous belongings). The mixture of the risk-free asset and the market portfolio is a particular case of the CAL, which is the capital market line, CML.
2. B is right. A portfolio of the risk-free asset and a dangerous asset or a portfolio of dangerous belongings can lead to a greater risk-return tradeoff than an funding in just one kind of an asset, as a result of the risk-free asset has zero correlation with the dangerous asset.
3. B is right. Buyers may have completely different optimum portfolios relying on their indifference curves. The optimum portfolio for every investor is the one with highest utility; that’s, the place the CAL is tangent to the person investor’s highest doable indifference curve.
4. B is right. Though the optimum dangerous portfolio is the market portfolio, extremely riskaverse buyers select to take a position most of their wealth within the risk-free asset.
5. B is right. Though the capital allocation line consists of all doable combos of the risk-free asset and any dangerous portfolio, the capital market line is a particular case of the capital allocation line, which makes use of the market portfolio because the optimum dangerous portfolio.
6. A is right. The market consists of all dangerous belongings, or something that has worth; nonetheless, not all belongings are tradable, and never all tradable belongings are investable.
7. A is right. The optimum dangerous portfolio is the market portfolio. Capital market concept assumes that buyers have homogeneous expectations, which signifies that all buyers analyze securities in the identical manner and are rational. That’s, buyers use the identical likelihood distributions, use the identical inputs for future money flows, and arrive on the identical valuations. As a result of their valuations of all belongings are similar, all buyers will spend money on the identical optimum dangerous portfolio (i.e., the market portfolio).
8. C is right. Theoretically, any level above the CML will not be achievable and any level under the CML is dominated by and inferior to any level on the CML.
9. B is right. As one strikes additional to the precise of level M on the capital market line, an rising quantity of borrowed cash is being invested out there portfolio. Which means there’s adverse funding within the risk-free asset, which is known as a leveraged place within the dangerous portfolio.
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11. A is right. The combos of the risk-free asset and the market portfolio on the CML the place returns are lower than the returns available on the market portfolio are termed
12. “lending” portfolios.
13. C is right. Buyers are able to avoiding nonsystematic danger by forming a portfolio of belongings that aren’t extremely correlated with each other, thereby lowering complete danger and being uncovered solely to systematic danger.
14. B is right. Nonsystematic danger is particular to a agency, whereas systematic danger impacts the whole economic system.
15. B is right. Solely systematic danger is priced. Buyers don’t obtain any return for accepting nonsystematic or diversifiable danger.
16. C is right. The sum of systematic variance and nonsystematic variance equals the full variance of the asset. References to complete danger because the sum of systematic danger and nonsystematic danger check with variance, to not danger.
17. B is right. Available in the market mannequin, R_i5α_i 1β_iR_m 1e_i, the intercept, αi, and slope coefficient, βi, are estimated utilizing historic safety and market returns.
18. B is right. Available in the market mannequin, R_i5α_i 1β_iR_m 1e_i, the slope coefficient, βi, is an estimate of the asset’s systematic or market danger.
19. A is right. Available in the market mannequin, R_i5α_i1β_iR_m1e_i, the intercept, αi, and slope coefficient, βi, are estimated utilizing historic safety and market returns. These parameter estimates then are used to foretell firm-specific returns {that a} safety might earn in a future interval.
20. A is right. Safety 1 has the best complete variance; 0.0625 5 0.25² in comparison with Safety 2 and Safety 3 with a complete variance of 0.0400.
21. C is right. Safety 3 has the best beta worth;
22. 1_:60₅ρ 3;mσ3 ₅ ð0:80Þð20percentÞ σ_m                     10%
23. in comparison with Safety 1 and Safety 2 with beta values of 1.50 and 1.40, respectively.
24. B is right. Safety 2 has the bottom beta worth;
25. 1_:40₅ρ 2;mσ2 ₅ ð0:70Þð20percentÞ σ_m                     10%
26. in comparison with Safety 1 and three with beta values of 1.50 and 1.60, respectively.