Question 2(10 marks)

Consider a market with two risky assets A and B. M is the market portfolio. F is the risk-free asset. This is a perfect market with no taxes or other frictions, and the prices given are equilibrium prices. All returns are annual returns.

			Correlation Matrix
	Expected Return	Standard Deviation	A	B	M	F
A	11.21%	22%	1.0	0.2	0.4	0.0
B	18.68%	28%	0.2	1.0	0.6	0.0
M	17.00%	15%	0.4	0.6	1.0	0.0
F	3.00%	0%				1.0

1. Calculate the beta of security A and B. Show your workings and explain which security has a higher systematic risk (3 marks)

2. Suppose that you are forming a portfolio (called portfolio 1) with 60% weighting on security A and 40% weighting on security B. Calculate the expected return and the standard deviation of return for portfolio 1. Show your calculations. (3 marks)

3. Suppose that you intend to form a portfolio (called portfolio 2) which consists of market portfolio (M) and risk-free asset (F) with the expectation of obtaining the same expected return as portfolio 1 in part (b) above. What weights would achieve this result? Show your calculations. (3 marks)

4. What is the highest Sharpe Ratio in the market?? (1 mark)