The idea of an efficient frontier narrows down the number of potentially desired risky portfolios for rational
Question:
The idea of an efficient frontier narrows down the number of potentially desired risky portfolios for rational investors. Explain what determines the shape of such a frontier and the decision -making process of complete portfolio selection for a rational investor.
b) The fund manager is responsible for the following risky portfolio:
Stocks: | Weightings: |
Al | 24% |
Bt | 36% |
Gm | 40% |
|
|
The portfolio has expected return of 31% and total risk of 28%; The current risk-free rate of return is 6.2%.
|
i. Mr. Johnson decides to invest 75% in the above fund (risky portfolio) with the remaining money allocated to the money market fund (risk free).
- What would the composition and corresponding weightings of Mr Johnson's complete portfolio be?
- Calculate the reward to volatility ratio of Mr Johnson's proposed portfolio.
ii. Mr Johnson's new investment strategy requires 24% return at least from the overall portfolio.
- Explain how this target rate of return would change the initial decision to invest 75% in the risky portfolio. Show your workings.
- Calculate the standard deviation of the new portfolio.
iii. Mr Brown prefers to maximise the expected return on the complete portfolio given that portfolio's standard deviation will not exceed 20%.
- Calculate what proportion should be invested in the fund's risky portfolio.
- Calculate the expected rate of return on Mr Brown's complete portfolio.
iv. It has been determined that Mr Brown's degree of risk aversion is 4.5.
- Explain how this would affect the proportion of Mr Brown's funds that should be invested in the risky fund. Show your workings.
- Calculate the expected value and standard deviation of the rate of return on Mr Brown's optimised portfolio.
Making Hard Decisions with decision tools
ISBN: 978-0538797573
3rd edition
Authors: Robert Clemen, Terence Reilly