PracticeSet3Solns

# PracticeSet3Solns - Finance 261 Practice Set 3...

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Finance 261 Practice Set 3 – Supplementary Examples Solutions 1. (a) E(R) = .6(7) + .4(12) = 9% σ = .4(21) = 8.4% (b) E(R) = -.5(7) + 1.5(12) = 14.5% σ = 1.5(21) = 31.5% (c) E(R) = (0)(7) + (1.0)(12) = 12% σ = 20% Note: (i) Leveraging a portfolio results in both higher expected return and risk. (ii) When one asset is risk free, the risk of the portfolio depends entirely on the proportion of funds invested in the risky asset. ie σ p = w risky asset σ risky asset 2. If CCL is in equilibrium the relationship is: 14 = R f + [E(R m ) – R f ] β = 6 + [E(R m ) – 6]1.1 The slope of the SML is the market risk premium, [E(R m ) – R f ] Solving for E(R m ) gives 13.27%, resulting in a slope of 7.27. 3. (d) Portfolio D is dominated by Portfolio B. B offers a higher return for a lower risk. 4. (a) β i = COV im m σ 2 where COV im = ρ im σ i σ m Thus COV AM = .9(20%)(23%) = 414 COV BM = 0.5(31%)(23%) = 356.5 = (23%) 2 M 2 = 529 β A = COV AM M 2 = 414 529 = 0.782 β B = 3565 529 . = 0.674 (b) SML equation = + [E(r r f m ) - r f ] β i 1

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E(r i ) = 6% + (10% - 6%) β i (c) Required rate for A = 6% + [10% - 6%](0.782) = 9.128% Required rate for B = 6% + 4(0.674) = 8.69% 5. (a) The equation of the CML is p m f m f p ) R R ( E R ) R ( E σ
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## This note was uploaded on 10/17/2010 for the course FF f taught by Professor F during the Spring '10 term at Clayton.

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PracticeSet3Solns - Finance 261 Practice Set 3...

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