ECON_134b_-_Section_Handout_3

ECON_134b_Section_ - b Now suppose your client decides to invest a proportion of money into your fund such that he expects a rate of return of 16

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ECON134b: Capital Allocation Practice Problems Q0. Correction of Questions 4 and 5 from last week’s handout (Additional exercise: calculate the risk-aversion coefficient that would make Matthew indifferent between the T-bill and the stock.) Q1. Consider the risk aversion-utility formula: U = E(r) - ½A 2 a) Draw the indifference curve in the expected return-standard deviation plane for an investor with a risk aversion coefficient of 3 and a utility level of 0.5. b) Draw the indifference curve in the expected return-standard deviation plane for an investor with a utility of 0.4 and a risk-aversion coefficient of 4. How does your answer compare to a)? Q2. You manage a risky portfolio with an expected return of 18%, a standard deviation of 28%, and a T-bill rate of 8%. You have a client who chooses to invest 70% of a portfolio in your fund and 30% in a T-bill money market fund. a) What are the expected return and standard deviation on your client’s portfolio?
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Unformatted text preview: b) Now suppose your client decides to invest a proportion of money into your fund such that he expects a rate of return of 16%. What would be the standard deviation of the rate of return on this portfolio? Q3. You estimate that a passive portfolio, that is, one invested in a risky portfolio that mimics the S&P 500 stock index, yields an expected rate of return of 13% with a standard deviation of 25%. You manage an active portfolio with expected return 18% and standard deviation 28%. The risk free rate is 8%. a) Draw the CML and your funds’ CAL on an expected return-standard deviation diagram b) What is the slope of the CML? Q4. Suppose that there are many stocks in the security market and that the characteristics of A and B are given as follows: Stock Expected Return Standard Deviation A 10 5 B 15 10 Correlation = -1 Assume it is possible to borrow at the risk-free rate. What must be the value of the risk-free rate?...
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This note was uploaded on 12/05/2011 for the course ECON 134b taught by Professor Johnhartman during the Fall '11 term at UCSB.

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