Now assume, that apart from the securities in problem 1, you also have the market portfolio....

 

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Now assume, that apart from the securities in problem 1, you also have the market portfolio. Consider the following forecasts of returns on two risky assets (r and r2), risk-free asset (r), and the market (): The forecasts for the two risky assets are identical as in problem 1. State (Scenario) 1 (Extreme boom) 2 (Boom) Probability 0.1 0.15 3 (Normal growth) 0.4 4 (Recession) 0.2 5 (Extreme recession) 0.15 ii. ri 12 rf KM 9% 7% 5.66% 12% 5% 12% 5.66% 10% 10% 5.66% 8% 4% 6% 3% 5.66% 6% 8% -9% 5.66% -2% A. Compute the expected return, standard deviation for the market (E(M) and M), as well as B₁ and 3₂. (5 points) B. Mixing the Market Portfolio and Assets 1 and 2: i. Assume that the risky portfolio you are currently holding is the market portfolio M. For security 1, do the following. First, form six portfolios with the following weights on security 1: w₁-10, 0.2, 0.4, 0.6, 0.8, and 1} (and WM-1-wi) and regard them as the opportunity set obtained by combining two risky portfolios (1 and M). Next, compute E(r), o, and ß for each such portfolio. Finally, plot this opportunity set in a graph. Should you continue to hold M as your risky portfolio or should you instead hold a combination of security 1 with M as your risky portfolio? Please explain why or why not. (5 points) Repeat the same exercise for security 2. (5 points) Now assume, that apart from the securities in problem 1, you also have the market portfolio. Consider the following forecasts of returns on two risky assets (r and r2), risk-free asset (r), and the market (): The forecasts for the two risky assets are identical as in problem 1. State (Scenario) 1 (Extreme boom) 2 (Boom) Probability 0.1 0.15 3 (Normal growth) 0.4 4 (Recession) 0.2 5 (Extreme recession) 0.15 ii. ri 12 rf KM 9% 7% 5.66% 12% 5% 12% 5.66% 10% 10% 5.66% 8% 4% 6% 3% 5.66% 6% 8% -9% 5.66% -2% A. Compute the expected return, standard deviation for the market (E(M) and M), as well as B₁ and 3₂. (5 points) B. Mixing the Market Portfolio and Assets 1 and 2: i. Assume that the risky portfolio you are currently holding is the market portfolio M. For security 1, do the following. First, form six portfolios with the following weights on security 1: w₁-10, 0.2, 0.4, 0.6, 0.8, and 1} (and WM-1-wi) and regard them as the opportunity set obtained by combining two risky portfolios (1 and M). Next, compute E(r), o, and ß for each such portfolio. Finally, plot this opportunity set in a graph. Should you continue to hold M as your risky portfolio or should you instead hold a combination of security 1 with M as your risky portfolio? Please explain why or why not. (5 points) Repeat the same exercise for security 2. (5 points)

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solution EB B Na KR Page 1 ER EB B ER A first we compute expected return with the help o... View the full answer