All sub-questions a) - l) relate to the following information:

You are of the view that the market is not in a CAPM equilibrium.Therefore, you want to construct an Active Portfolio which, when combined with the Market Portfolio, will be expected to earn a superior Sharpe Ratio then the Market Portfolio alone.

The risk free rate in the market is 3% and the total return on the Market Portfolio is 10%.The risk of the Market Portfolio, measured by its standard deviation, is 11%.

You believe the following 3 assets could form part of your Active Portfolio:

Stock A

Stock B

Stock C

Beta

0.6

1.1

1.5

Actual Total Return

8.1%

10.7%

15.0%

Total Risk (Standard Deviation)

18.80%

17.50%

21.50%

d) Describe where each of the stocks A, B and C would plot in relation to the Security Market Line (on the line, over the line or below the line) (1 mark)

e) Which of the 3 stocks will you include in your Active Portfolio? (0.5 marks)

f) What is the unsystematic risk of each of the 3 stocks (defined by the residual variance)?

Stock A's unsystematic risk (variance) is ___________?

Stock B's unsystematic risk (variance) is ___________?

Stock C's unsystematic risk (variance) is ___________?

(1.5 marks)

Enter your answer to 3 decimal places eg if your answer is 6.54% enter as 0.065.

g) What is the alpha of the Active Portfolio? (1 mark)

Enter your answer to 4 decimal places eg if your answer is 6.54% enter as 0.0654.

h) What is the beta of the Active Portfolio? (1 mark)

Enter your answer to 2 decimal places eg if your answer is 1.732 enter as 1.73

i) What is the reward to risk ratio of the Active Portfolio? (2 marks)

Enter your answer to 3 decimal places eg if your answer is 6.54% enter as 0.065.

j) Derive the information ratio for the Active Portfolio and provide a description of what the information ratio means. (1.5 marks)

Enter your answer to 3 decimal places eg if your answer is 6.54% enter as 0.065.

k) The optimal weighting in the Active Portfolio w*_Ais____________and the optimal weighting in the Market Portfolio is ___________? (2 marks)

l) What is the Sharpe Ratio of your resulting Optimal Risky Portfolio P* comprising the combination of your Active Portfolio with the Market Portfolio? (2 marks)