The expected return of the market portfolio (M) is 10% pa, the risk free rate of return (r_f) is 4% pa. Based on this information, Robert attemted to draw the Securities Market Line (SML) to identify investment opportunities in the market. Along with risk-free return (r_f) and the market portfolio (M) Robert places four securities on the graph based on their risk and return characteristics. However, he left the chart incomplete, as shown below.

 

SML 15% m 14% D 13% F 12% 11% 10% 9% B C 8% E(R) 7% 6% 5% 4% 3% A 2% 1% 0% 0.5 1.5 N 2.5

In the incomplete SML graph above, there are six securities A, B, C, D, E, and F. Identify which one of these is

1. the risk-free return (r_f) 
2. the market portfolio (M)

Justify your answers with reasons. 

1. If Robert wants to earn 3% alpha from his investment which one of the securities (among A, B, C, D, E and F) he should select? Justify your answer with calculations of alpha for your chosen security.

Transcribed Image Text:

E(R) SML D E 15% 14% 13% 12% 11% 10% 9% B C 8% 6% 5% 4% 3% A 2% 1% 0% 0.5 F 1.5 2 2.5 B B E(R) SML D E 15% 14% 13% 12% 11% 10% 9% B C 8% 6% 5% 4% 3% A 2% 1% 0% 0.5 F 1.5 2 2.5 B B

Answer rating: 100% (QA)

To identify the riskfree return rf and the market portfolio M from the SML graph 1 Riskfree return r... View the full answer