Suppose that investor A holds a portfolio (portfolio A) consisting of three shares. The portfolio return
equal to 8% while its risk (st.dev) equals 15%. The market portfolio (consisting of n shares) at this time of
reference rewards investors with 13% and its risk equals 10%. The risk free interest rate is 3%.
Q:Is this portfolio (portfolio A) an efficient one? What is the diversification benefit of another investor (investor
B) who holds a perfectly diversified portfolio (portfolio B) which embeds the same level of risk with that of
portfolio A (i.e. σΑ=σΒ=15%)? How can this portfolio (portfolio B) be constructed? How does the existence
of the risk free interest rate affect the optimum portfolio construction? Explain.
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