Hello,

I don't understand the response, a) when we write down the optimal allocation function, gamma is supposed to by = 1 with the information provided in the question. Why do we have a 2 in the equation? Is it gamma or something else ?

Thank you for your time

Question 3 (15 Points) [CAPM] There are only two risky assets in the economy, A and B. The market portfolio in an economy has an expected market return of 9%% and variance of 37/1200 x 0.0308. The riskfree rate in the economy is 3%. Stock A has an expected return of 5% and volatility of 10%. Stock B has an expected return of 10% and volatility of 20%. The correlation of returns on stocks A and B is 50%. All investors have meanvariance utility functions1 U = up $1103 (3) indicates the portfolio they are holding). a) Find the optimal portfolio composition for an investor Y with riskaversion coe'icient -Make sure you identify the weights of stocks A and B. b) You decide to invest in a portfolio (P) composed of two stocks A and B. Your portfolio is invested 50% in stock A and 50% in stock B. What is your portfolio's: i) Expected return 11) Volatility iii) Sharpe ratio iv) Beta v) Unexplained return (Jensen's alpha) by CAPM ) vi Is your portfolio on the Capital Market Line (CML)? Is it on the Security Market Line (SML)? SOLUTION a) Inside the market portfolio: 1 96 2111A X5+(1'1UA)X 1D 1 5 wA : 0 = 16.7%, 11.13 = 1 10.6% = 0 = 83.3% The optimal allocation to the tangench market portfolio is given by: 2L5? to win This means that the optimal allocation to the tangency portfolio for investor Y is: 9.17% 3% = 1 .d 2 x 0.0308 00% Her portfolio is thus: 1113f = 0, WA 2 15.7%, 1.03 = 83.3%