QUESTION 4 (25 marks) (a) There are two assets, and in a portfolio with the following properties: Asset Standard Deviation (%) 15 10 Given the correlation coefficient between the assets to be 0.3.

(i) Derive a formula for and determine the composition of the investors minimum variance portfolio. (6 marks)

(ii) Explain the benefits of diversification in general terms. (2 marks)

(b) An investor can only invest in 2 assets in the market with the following properties: Asset Expected Return (%) Standard Deviation (%) 6% 18% 3% 0%

(i) State the formula for the market price of risk for this market. (1 mark)

(ii) Show that efficient frontier for the investor is a straight line passing through the points (0, 0.03) and (0.12, 0.05) in the (standard deviation, expected return) space. (8 marks) A third security becomes available to the investor, it has an annualized expected return of 5.5% and an annualized standard deviation of 12% that is independent from asset and asset .

(iii) Determine the amount to invest in security and security such that the variance of your portfolio is minimized. (8 marks)

ANSWERS MUST TYPE