Assume that you manage a risky portfolio with an expected rate of return of 15% and a standard deviation of 40%. The T-bill rate is 5%.

Your client has a total investment budget of $760,000. She decides to invest in your risky portfolio a proportion of her total investment budget with the remainder in a T-bill money market fund so that her overall portfolio will have an expected rate of return of 13%.

Required

1. You estimate that a passive portfolio invested to mimic the S&P 500 stock index provides an expected rate of return of 12% and a standard deviation of 34%. Draw the CML and your funds CAL on an expected return/standard deviation diagram.

2. Your client is considering adopting a passive strategy. She prefers investing in the market portfolio a proportion (y) that maximizes the expected return on the overall portfolio subject to the constraint that the overall portfolio standard deviation will not exceed 32%.

a- What is the expected rate of return on the overall portfolio?

b- Do you agree with her? Support your answer with relevant calculations.

3- Redo question 5-b assuming your required portfolio management fee is 1.95% of total assets under management.

4- Draw the CML and your funds CAL on an expected return/standard deviation diagram. Show the position of your client in questions 5 and 6.