Suppose that investor A holds a portfolio (portfolio A) consisting of three shares. The portfolio return is equal to 8% while its risk (st.dev)...
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Suppose that investor A holds a portfolio (portfolio A) consisting of three shares. The portfolio return

is

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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