Cole is looking to combine two stocks, A and B, into a risky portfolio that will be combined with U.S. treasury bills . Cole has used historical data to estimate that A returns have a standard deviation of 4.89% and B returns have a standard deviation of 19.11%. The riskless asset that matches this investment horizon has an expected return of 0.93% and the expected return to the market is 5.65%.

• Use the capital asset pricing model to determine the expected rate of return for A using a beta value of 0.6.
• Use the capital asset pricing model to determine the expected rate of return for B using a beta value of 1.89.
• Using the correlation between the two stocks, as well as the expected rates of return and standard deviation, the Cole has determined that the risky portfolio weights that maximize the Sharpe ratio are 0.95 for A and 0.05 for B. Using these weights, what is the expected return of the risky portfolio.
• Assuming that the correlation between the two stocks is 0.4121, what is the standard deviation of the risky portfolio using the same weights as above?
• Cole would combine the risky portfolio with the riskless asset according to their risk preferences. Let's start by assuming that the investor is risk-averse and will lend at the risk-free rate so that only 36% of their investment funds are put into the risky portfolio. What is the expected return on a per unit of risk basis for the complete portfolio?
• Now let's assume that the investor is less risk-averse and will borrow to put 112% of their investment funds into the risky portfolio. Assuming that this investor is able to borrow at the risk-free rate, what is the expected return on a per unit of risk basis for this complete portfolio?

Answer rating: 100% (QA)

Lets solve each part step by step 1 Expected rate of return for stock A using CAPM Beta 06 Riskfree ... View the full answer