Problem set #7 Solution - Suggested solutions to Problem...

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Suggested solutions to Problem Set 7 Econ 136, 2009 November 30, 2009 1 True or False a) False. The optimal portfolio share of stocks is EER 2 which is positive when EER > 0 even if A is very large. Highly risk-averse investors may hold less in risky assets, but they should hold a positive amount. b) True. In a CAPM equilibrium, the market portfolio is the tangency portfolio, which, by defini- tion, has the highest Sharpe ratio. c) True. According to the mutual fund theorem, every investor should hold risky assets in the same relative proportion. This is violated here, because Xing holds growth and value stocks in the ratio 1:2, while Sung Bin holds in the ratio 1:3. d) False. If CAPM holds, investors hold some combination of the market portfolio and the riskfree asset. By definition, all stocks are part of the market portfolio. A stock with expected rate of return below the riskfree rate is held because it has a negative beta: it provides insurance against fluctuations in the investor’s portfolio. 2 CAPM
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Problem set #7 Solution - Suggested solutions to Problem...

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