Question 3 (this question has two parts, (a) & (b)) (a) optimal portfolio of ris

Question

Question 3 (this question has two parts, (a) & (b)) (a) optimal portfolio of risky assets (P) and T-Bills. The information below refers to these assets. Your client, Bo Regard, holds a complete portfolio that consists of an E(Rp) Standard Deviation of P T-Bill rate Borrowing rate Proportion of Complete Portfolio in P Proportion of Complete Portfolio in T-Bills 12.00% 7.20% 3.00% 4.80% 80% 20% Composition of P: Stock A Stock B Stock C Total 40.00% 25.00% 35.00% 100.00% i) Draw the Capital Allocation Line (CAL) with leverage for your client. li) What are the reward-to-variability ratios of your clients CAL with and without leverage? ii) What are the proportions of Stocks A, B, and C, respectively in Bo's complete portfolio? 38

Explanation / Answer

(a) (i) Expected return on Bo's complete portfolio, E(rC) = risk free rate (T-bill rate) + (E(Rp) - T-bill rate)/StdDev of P * StdDev of C

StdDev. of C = 0.8 * 7.20% = 5.76%

=> E(rC)= 3% + (12% - 3%)/7.2% * 5.76% = 10.2%

(iii) Proportion in

A = 0.8 × 40% = 32%

B = 0.8 × 25% = 20%

C = 0.8 × 35% = 28%

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