Active Portfolio Management [8 marks]

Consider a small economy that there are only two risky assets, Stock (S) and Bond (B). CAPM was used as the baseline model for Black Litterman Model. Use the information in the following tables.

Baseline model estimations:

	Risk premium
Stock	5%
Bond	2%

Estimation error of the baseline model as variance matrix:

	Stock	Bond
Stock	0.0025	0.00015
Bond	0.00015	0.0001

a) The manager represented his view as below:

PR^T = Q + P = (-1 1) R = (R_S R_B) Q = 1% = 4%

What is the view of the manager in plain language? [3 marks]

b) By considering the managers view, what is the view of the baseline model? [1 mark]

c) What is the variance of the baseline models view? [1 mark]

d) What are the Black Litterman adjusted values of the risk premia of Stock and Bond? [3 marks]