Ch07 revised

# Ch07 revised - CHAPTER 7 CAPITAL ALLOCATION BETWEEN THE RISKY ASSET AND THE RISK-FREE ASSET 1 Expected return =(0.7 18(0.3 8 = 15 Standard

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CHAPTER 7: CAPITAL ALLOCATION BETWEEN THE RISKY ASSET AND THE RISK-FREE ASSET 1. Expected return = (0.7 × 18%) + (0.3 × 8%) = 15% Standard deviation = 0.7 × 28% = 19.6% 2. Investment proportions: 30.0% in T-bills 0.7 × 25% = 17.5% in Stock A 0.7 × 32% = 22.4% in Stock B 0.7 × 43% = 30.1% in Stock C 4. Client P 0 5 10 15 20 25 30 0 10 20 30 40 σ (% 29 E(r) % CAL (Slope = 0.3571) 7-1

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5. a. E(r C ) = r f + y[E(r P ) – r f ] = 8 + y(18 - 8) If the expected return for the portfolio is 16%, then: 16 = 8 + 10 y 8 . 0 10 8 16 y = - = Therefore, in order to have a portfolio with expected rate of return equal to 16%, the client must invest 80% of total funds in the risky portfolio and 20% in T-bills. b. Client’s investment proportions: 20.0% in T-bills 0.8 × 25% = 20.0% in Stock A 0.8 × 32% = 25.6% in Stock B 0.8 × 43% = 34.4% in Stock C c. σ C = 0.8 × σ P = 0.8 × 28% = 22.4% 6. a. σ C = y × 28% If your client prefers a standard deviation of at most 18%, then: y = 18/28 = 0.6429 = 64.29% invested in the risky portfolio
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## This note was uploaded on 11/02/2011 for the course FIN 310 taught by Professor Ardaugh during the Fall '09 term at Ill. Chicago.

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Ch07 revised - CHAPTER 7 CAPITAL ALLOCATION BETWEEN THE RISKY ASSET AND THE RISK-FREE ASSET 1 Expected return =(0.7 18(0.3 8 = 15 Standard

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