The market portfolio has an expected return of 11.6 percent and a standard devia

Question

The market portfolio has an expected return of 11.6 percent and a standard deviation of 21.6 percent. The risk-free rate is 4.6 percent.

a. What is the expected return on a well-diversified portfolio with a standard deviation of 8.6 percent? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Expected return %

b. What is the standard deviation of a well-diversified portfolio with an expected return of 19.6 percent? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Standard deviation %

Explanation / Answer

As a well-diversified portfolio has no unsystematic risk, this portfolio should lie on the Security Market Line (SML). The slope of the SML equals: Slope(SML)= (Expected Return on the Mkt. Portfolio-Risk-FreeRate)/Std. Devn. Of mkt. Portfolio    (0.116-0.046)/0.216 = 0.32 a. Expected return on a well-diversified portfolio with a standard deviation of 8.6 percent Exp.Return= RFR+ Slope*Std.Devn. 0.046+(0.32*0.086) 0.07352 ie. 7.35% (Expected Return %) b. Standard deviation of a well-diversified portfolio with an expected return of 19.6 percent Exp.Return= RFR+ Slope*Std.Devn. 0.196=0.046+(0.32*S/D) Std. Deviation= 0.46875 ie. 46.88% (Standard Deviation %)

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