The file Project 2.xls in the Projects folder contains the monthly return to Exxon Mobil

(XOM) and Darden Restaurants (DRI)1 in 2005-2009, as well as the market return (MKT)

and the risk-free rate (RF) in the same time period. Use these data to answer the questions

below:

i. Compute the average return, the standard deviation, and the correlation for Exxon

and Darden.

ii. If you can only invest in the risk-free asset and either Exxon or Darden, which one

do you pick?

iii. If you can only invest in the risk-free asset and either Exxon or Darden and your

target standard deviation is 15% per annum, what will be your best possible expected

monthly return? What weight does the risk-free asset take in your portfolio?

iv. Compute the average return, standard deviation, and the Sharpe ratio of the portfolio

that invests 80% in Exxon and 20% in Darden

v. Does the existence of Exxon and Darden violate the CAPM? (Hint: You will need

to use the data on the market excess returns).

vi. Redo (iv) assuming that the correlation between Exxon and Darden is 0.6. What

does it tell you about the benets of diversication?

vii. What combination of Exxon and Darden creates the minimum variance portfolio

(MVP)? What are the average return, standard deviation and the Sharpe ratio of

this portfolio? (Hint: use the Solver add-in)

viii. What combination of Exxon and Darden creates the mean-variance efficient portfolio

(MVE)? What are the average return, standard deviation and the Sharpe ratio of

this portfolio? (Hint: use the Solver add-in)

ix. Bonus question: Estimate the market model for Exxon and the market model for

Darden. Do either Exxon or Darden violate the CAPM by a statistically signicant

amount

x. Assume that Exxon and Darden are the only two stocks in the economy. Under the

CAPM, what are the average return and standard deviation of the market portfolio?

What are the average return and standard deviation of the zero-beta portfolio? (Hint:

Use your solution to (viii) to answer this question)

xi. Bonus question: Redo (iii) assuming that now you can invest in Exxon, Darden, and

the risk-free asset simultaneously. What are the weights of Exxon, Darden, and the

risk-free asset in the portfolio that delivers the best possible return for the target

standard deviation of 15% per annum?

xii. Assume that Exxon and Darden are the only two stocks in the economy and there

is no risk-free asset. For each of the following three points - (0.83%, 5.44%), (1.03%,

6.53%), (0.95%, 5.31%) - answer two questions:

(a) Will you want to choose it?

(b)Can you have it? The first number of the pair is always expected return. (Hint 1:

use Solver. Hint 2: do not forget comparing the points with MVP). (20 points)

xiii. How would your answer to (xii) change if the risk-free asset is available? (10 points)