Chap5 Questions - What, if anything, does this imply about...

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THE ECONOMICS OF FINANCIAL MARKETS R. E. BAILEY Exercises for Chapter 5 Portfolio selection: the mean-variance model 1. An investor uses the mean-variance criterion for selecting a portfolio of two risky assets. As- set 1 has an expected return of 20% and a variance of 4. Asset 2 has an expected return of 60% and a variance of 36. There is no risk-free asset available. (a) Explain how to construct the efficient portfolio frontier for the cases in which the cor- relation coefficient between the returns, ρ 12 , is equal to +1 and also when it is equal to - 1 . (b) Describe, in general terms, how to construct the portfolio frontier when - 1 < ρ < +1 . 2. You are given the following information about three assets: Asset: μ j σ j 1 8% 8% 2 16% 50% 3 11% 10% The risk-free interest rate, r 0 , equals 6%. (a) Calculate and interpret the Sharpe ratio for each of the three assets. (b) Suppose that the risk (standard deviation) of a benchmark portfolio is given by 20%.
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Unformatted text preview: What, if anything, does this imply about the comparative performance of the assets? (c) You are now told that a mean-variance efficient portfolio, “ E ”, is available with μ E = 12% and σ E = 15% . What inferences can you draw from this information? 3. Consider a world with several risky assets and in which an investor can borrow at a given interest rate which is different (higher) than the rate at which the investor can lend. (a) Construct the efficient portfolio frontier. (b) Depict an equilibrium for an investor who chooses to borrow. (c) Suppose that the interest rate at which the investor can borrow increases. Examine the implications for the investor’s optimal investment decisions. *****...
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This note was uploaded on 03/21/2011 for the course ECON 6120 taught by Professor Crabbe during the Spring '11 term at University of Ottawa.

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