Assume analysts provide the following information. Assume short sales are allowed.

Stock	Expected Return	Standard Deviation
1	12%	4%
2	10%	6%
3	9%	5%

Correlation Coefficients	Stock 1	Stock 2	Stock 3
Stock 1	1	0.75	0.5
Stock 2		1	-0.25
Stock 3			1

a) What is the optimum portfolio if the lending and borrowing rate is 4%? What are the expected return and the standard deviation of this optimal portfolio? (4 marks)

b) Simon claims that there is an efficient portfolio called Portfolio A having expected return 8% and standard deviation 4%. Draw the Capital Market Line and mark the positions of Portfolio A, Stock 1, 2, 3 and the optimum portfolio in (a). (4 marks)

c) Validate Simon's claim in question (b). (2 marks)

Answer rating: 100% (QA)

a The optimal portfolio is a portfolio with the highest Sharpe ratio The Sharpe ratio is calculated by subtracting the riskfree rate from the expected ... View the full answer