Question 1

You are advising a client to construct a portfolio worth 20 million. Youre advising your client to consider combining three index funds with a risk-free asset. The data below presents annualised returns for these index funds in different economic scenarios. However, annualized returns are estimated from index funds given daily price data. Nonetheless, the associated probabilities are your estimates reflecting market-wide perceptions.

State	Probability	HSBC FTSE 250	Black rock Growth	Barclays FTSE 100
Boom	0.15	0.26	0.40	(0.38)
Good	0.45	0.10	0.18	0.15
Poor	0.35	0.02	(0.19)	(0.03)
Bust	0.05	(0.08)	(0.32)	(0.06)
weights		0.35	0.30	0.35

1. Calculate the portfolio returns and standard deviation if no investment is made in T-Bills. Assume the weights given in the table.

[15 Marks]

1. If the T-bills rate is 2.5%, calculate the risk premium investors demand for buying one unit of risk.

[5 Marks]

1. Discuss the role of investors risk preferences in portfolio construction. As a financial advisor, what type of assets would you recommend to a risk-averse and a risk-aggressive investor?

[5 Marks]

[25 Marks]