This exercise concerns the theory of Section 2.3. Suppose that a financial market consists of two securities
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This exercise concerns the theory of Section 2.3. Suppose that a financial market consists of two securities with expected returns of 6% and 8%, and standard deviations of 1% and 2%, respectively. Let the correlation ρ = 0.3.
(a) Consider two portfolios: x = (1/2, 1/2), and y = (1/3, 2/3). Let Rx and Ry be the returns corresponding to these portfolios. Find (a) E{Rx}; (b) Cov{Rx,Ry}.
(b) Now, we add an additional risk-free security with a risk-free interest of 3%. Find the optimal combination of the two risky securities. Derive and graph the capital market line. Find an optimal portfolio that invests 60% in the risk-free security. Where is the corresponding point on the trade-off line?
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a In terms of Section 23 m m m2 106 108 Then Rx x m 107 The covariance matrix c 0 01 030102 03 0...View the full answer
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