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Unformatted text preview: UNIVERSITY OF TORONTO Joseph L. Rotman School of Management RSM332 PROBLEM SET #2 1. Suppose the CAPM holds. The market portfolio has two risky assets, A and B . The risk-free rate of return is 2%. You collect the following data on probabilities of different states happening and the returns of the two risky assets in different states: State Probability R A R B State 1 0.3 7% 14% State 2 0.4 6%- 4% State 3 0.3- 8% 8% (a) Calculate expected returns, variances, standard deviations, covariance, and corre- lation of returns of the two risky assets. (b) Calculate expected return and standard deviation of the market portfolio. (c) An investor wants to create a portfolio of assets A and B that has a beta of 1 . 5. The investor has $1 , 000 available to invest. Explain how this investor can do it. What is the expected return of this portfolio? (d) Suppose now that the lending rate differs from the borrowing rate: you can borrow at R F,b = 2% but can deposit money in a risk-free asset only at R F,l = 0 . 5%. There are three investors. The first one wants a portfolio with standard deviation of 3%, the second one wants a portfolio with standard deviation of 5%, and the third one wants a portfolio with standard deviation of 7%. Each investor has only $1,000 to invest. Describe how much each investor should allocate to different assets to create the desired portfolios. What is the expected return of the portfolio of each investor?...
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- Fall '08