Question: Consider the following two risky asset worlds: Security S Security B Expected return 0.16 0.10 Variance 0.0735 0.0563 Beta () 1.2 0.9 Treasury bond rate

Consider the following two risky asset worlds:

Security S

Security B

Expected return

0.16

0.10

Variance

0.0735

0.0563

Beta ()

1.2

0.9

Treasury bond rate

4%

Market return

9%

coefficient of Correlation:

-0.005

Answer the following questions:

  1. Explain why the risk of any portfolio composed of (S) and (B) is less than weighted average risk of the two securities
  2. Calculate the expected return and the variance of a portfolio composed of (60%: S, 40%: B)
  3. If the minimum variance portfolio of the two securities is (43.41%: S, 56.59%: B), what is the expected return and the variance of this portfolio?
  4. Explain Why the risk of any portfolio composed of S and B is greater than the risk of the portfolio in question 3.
  5. Use the CAPM to evaluate the expected return of the two security (S). Explain why the expected return calculated in question 5 equals to the market return if beta equals 1.

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