All sub-questions a) - l) relate to the following information: You are of the view that the
Question:
All sub-questions a) - l) relate to the following information:
You are of the view that the market is not in a CAPM equilibrium.Therefore, you want to construct an Active Portfolio which, when combined with the Market Portfolio, will be expected to earn a superior Sharpe Ratio then the Market Portfolio alone.
The risk free rate in the market is 3% and the total return on the Market Portfolio is 10%.The risk of the Market Portfolio, measured by its standard deviation, is 11%.
You believe the following 3 assets could form part of your Active Portfolio:
Stock A
Stock B
Stock C
Beta
0.6
1.1
1.5
Actual Total Return
8.1%
10.7%
15.0%
Total Risk (Standard Deviation)
18.80%
17.50%
21.50%
d) Describe where each of the stocks A, B and C would plot in relation to the Security Market Line (on the line, over the line or below the line) (1 mark)
e) Which of the 3 stocks will you include in your Active Portfolio? (0.5 marks)
f) What is the unsystematic risk of each of the 3 stocks (defined by the residual variance)?
Stock A's unsystematic risk (variance) is ___________?
Stock B's unsystematic risk (variance) is ___________?
Stock C's unsystematic risk (variance) is ___________?
(1.5 marks)
Enter your answer to 3 decimal places eg if your answer is 6.54% enter as 0.065.
g) What is the alpha of the Active Portfolio? (1 mark)
Enter your answer to 4 decimal places eg if your answer is 6.54% enter as 0.0654.
h) What is the beta of the Active Portfolio? (1 mark)
Enter your answer to 2 decimal places eg if your answer is 1.732 enter as 1.73
i) What is the reward to risk ratio of the Active Portfolio? (2 marks)
Enter your answer to 3 decimal places eg if your answer is 6.54% enter as 0.065.
j) Derive the information ratio for the Active Portfolio and provide a description of what the information ratio means. (1.5 marks)
Enter your answer to 3 decimal places eg if your answer is 6.54% enter as 0.065.
k) The optimal weighting in the Active Portfolio w*Ais____________and the optimal weighting in the Market Portfolio is ___________? (2 marks)
l) What is the Sharpe Ratio of your resulting Optimal Risky Portfolio P* comprising the combination of your Active Portfolio with the Market Portfolio? (2 marks)