Chapter 10 The Efficient Frontier and CAPM

1. Consider an investor with $100,000. There are two assets in the market: risk free asset

and a risky asset (A): = 0.2 ( ) = 30%

= 10%.

a.Suppose that the investor is interested in earning an expected return of 20%. How can she generate such an expected return? What will be the standard deviation of the investors portfolio in that case?

b.Suppose instead that the investor is interested in earning an expected return of 40%. How can she generate this expected return? What will be the standard deviation of the investors portfolio in that case?

3. You observe the following three assets in the market:

Risk Free Asset 3%

Expected return

Standard deviation

Asset A Asset B

10% 14% 7% 9%

a.Which of the two risky assets (A or B) is efficient (assume that at least one of them is efficient)?

b.You have $50,000 to invest and you want to receive an expected return of 12%. Is it possible? If yes, explain how you can earn your target expected return.