Mr Magoo is planning to invest 18m in one of two short-term portfolios. Both portfolios consist of

Mr Magoo is planning to invest £18m in one of two short-term portfolios. Both portfolios consist of four short-term securities from diverse industries. The correlation between the returns of the individual securities is thought to be close to zero.

(a) Mr Magoo's financial adviser has suggested that he use the capital asset pricing model (CAPM) to compare the portfolios. The current equity risk premium is estimated to be 5.5 per cent and the yield on short-dated Treasury bills is 4.5 per cent. Using the information provided, recommend which of the two portfolios should be selected.
(b) Briefly explain whether the CAPM and portfolio theory use the same measure of risk.
(c) Discuss whether you consider portfolio theory or the CAPM to be most appropriate when choosing between the portfolios in part (a).

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Equity Portfolio A investments Expected return (%) Standard deviation of retum (%) 1.5 0.0 0.8 1.0 Amount invested (Em) 3.6 5.4 5.8 3.2 17 8 10 13 4 12 Equity Expected return (%) 12 10 6 17 Portfolio B investments Standard deviation of return (%) Amount invested (£m) 1.2 0.7 0.3 1.6 10 2.6 5.2 2.8 4