Question 5 (8 marks): a. In broad terms, why is some risk diversifiable? Why are some risks non-diversifiable? Does it follow that an investor can control the level of unsystematic risk in a portfolio, but not the level of systematic risk? (2 marks) b. Stocks offer an expected rate of return of 18%, with a standard deviation of 22%. Gold offers an expected return of 10% with a standard deviation of 30%. In light of the apparent inferiority of gold with respect to both mean return and volatility, would anyone hold gold? If so, demonstrate graphically why one would do so. (3 marks) Page 3 of 5 FINM2416 Asset Pricing c. Considering the following information regarding the performance of a portfolio manager in a recent quarter: Manager's Manager's Benchmark Return Benchmark Return Weight Weight Stocks 1% 0.50 0.30 2% Bonds 2% 0.30 0.30 1.5% Treasury bills 0.75% 0.20 0.40 0.5% (i) Identify the Alpha of the manager's portfolio (ii) identify the contributions of asset allocation and security selection to relative performance. (3 marks) Question 5 (8 marks): a. In broad terms, why is some risk diversifiable? Why are some risks non-diversifiable? Does it follow that an investor can control the level of unsystematic risk in a portfolio, but not the level of systematic risk? (2 marks) b. Stocks offer an expected rate of return of 18%, with a standard deviation of 22%. Gold offers an expected return of 10% with a standard deviation of 30%. In light of the apparent inferiority of gold with respect to both mean return and volatility, would anyone hold gold? If so, demonstrate graphically why one would do so. (3 marks) Page 3 of 5 FINM2416 Asset Pricing c. Considering the following information regarding the performance of a portfolio manager in a recent quarter: Manager's Manager's Benchmark Return Benchmark Return Weight Weight Stocks 1% 0.50 0.30 2% Bonds 2% 0.30 0.30 1.5% Treasury bills 0.75% 0.20 0.40 0.5% (i) Identify the Alpha of the manager's portfolio (ii) identify the contributions of asset allocation and security selection to relative performance