The market contains 2 risky securities S ($1bln outstanding), T ($2bln outstanding) and risk-free security R ($3bln outstanding). There are two broad groups of investors (each group containing many individuals), one group I with coefficient of risk aversion A = 7, and another group J with coefficient of risk aversion A = 3. 

S's expected return and standard deviation are 6% and 5% respectively.

T's expected returns and standard deviation are 9% and 7% respectively. 

The correlation between S and T returns is 0.5

Return of R next period will be 3%

 

For the following questions, please explain your answer (calculations may not be necessary):

1. What is the ratio of S:T holdings for investor group I? What is the ratio of S:T holdings for investor group J? 

Both investor groups will hold the ideal portfolio that delivers the lowest possible risk for any given level of projected return, to use fully the diversity advantage. As a result, the S:T ratio for investment groups I and J will be the same. 

2. Will any of the groups, I or J, hold (long or short) positions in risk free asset? Which group will have a larger long position in R?

Answer rating: 100% (QA)

Both investor groups I and J will hold a long position in the riskfree asset R since it provides a guaranteed return with no risk The proportion of R ... View the full answer