Ann has $10,000 to invest and she hired you as an investment advisor to help her choose
Question:
Ann has $10,000 to invest and she hired you as an investment advisor to help her choose the best investment portfolio. There are two assets in the economy – A and B and a risk-free asset that returns 1% p.a. annually compounded. Information on Assets A and B can be found in the table below. The correlation coefficient between returns of A and B is 0.5. Expected Return Standard deviation A 13% 30% B 11% 20%
a) What is the most efficient risky portfolio she can invest in, given the assets A, B and the risk-free asset? Indicate the weights allocated in assets A and B, the expected return, and standard deviation of the identified portfolio. (3 marks)
b) Her colleague from work suggested asset C as a good investment opportunity. Asset C has a return of 11.5%, and a standard deviation of 20%. Would this asset be a better choice than the one found in a)? Why? On a single graph draw 2 CALs related to the portfolio identified in a) and asset C. (2 marks)
c) Ann wants to liquidate the investment 15 years from now. She informs you that, in addition to $10,000 she can invest now, she aims to invest $10,000 at the start of each year until (and including) year 10, for a total of $100,000 spread across 10 instalments. What would be the value of her investment portfolio at the end of year 15? Assume she decides to invest in portfolio identified in a) and use the expected return identified therein as a proxy for future returns. (3 marks)
d) List two potential issues that might lead to her investment not reaching the value found in c) and provide brief explanations. (2 marks)
