Based on the attached data, answer the questions below:

a)The client will notice that the Sharpe ratio of the hedge fund (Portfolio B) is much higher than that of the equity strategy (Portfolio A) and will ask why the optimal risky portfolio wouldnt be 100% of Portfolio B. How would you respond?

b)Your client vehemently believes in the semi-strong form of market efficiency as it relates to security selection. Is the performance of Portfolio A sufficient justification to convince the client otherwise - that markets are inefficient or at least less efficient? Why or why not?

c)Given your clients belief regarding market efficiency as it pertains to security selection, what portfolio substitution(s) would you make in your optimal portfolio? No calculations are necessary to answer this.

d)Your client is expected to ask why you are recommending the optimal complete portfolio instead of the optimal portfolio even though the latter has a higher expected return. How will you respond?

e)After meeting with the client, she appears to prefer the risk/return tradeoff of the optimal portfolio rather than that of the optimal complete portfolio. What does that indicate about your initial assumptions regarding the indifference curve?

Corr v Market Corr A&B: Covariance: Beta Portfolio B -1.10% 1.38% -7.13% 3.68% 2.72% 13.44% -2.11% 2.51% 4.24% 10.09% 1.27% -0.56% -0.86% 3.56% -1.62% 7.47% -2.09% 3.40% -0.32% 2.82% 4.95% -5.70% 5.90% -6.23% 1.78% 3.24% 10.52% 1.09% -17.02% 1.77% 13.19% 12.80% 3.82% 4.50% 8.29% 7.74% 4.09% -9.22% 1.35% -1.96% 8.12% -2.86% 1.15% 0.62% 6.39% 0.44% 1.18% 9.27% -1.09% -3.82% -0.06% 5.31% 2.78% -1.15% 7.09% 2.84% 5.94% -4.20% 1.17% 2.23% -5.05% S&P 500 -6.34% 7.77% 0.67% -2.43% -0.98% -6.26% -8.08% 1.91% 7.67% 0.88% -1.46% -1.93% 3.76% -6.06% -0.74% -7.12% -7.79% 0.66% -10.87% 8.80% 5.89% -5.87% -2.62% -1.50% 0.97% 8.24% 5.27% 1.28% 1.76% 1.95% -1.06% 5.66% 0.88% 5.24% 1.84% 1.39% -1.51% -1.57% 1.37% 1.94% -3.31% 0.40% 1.08% 1.53% 4.05% 3.40% -2.44% 2.10% -1.77% -1.90% 3.18% 0.14% 3.72% -0.91% 0.81% -1.67% 3.78% 0.03% 2.65% 0.27% 1.24% 90dBill 0.44% 0.38% 0.37% 0.32% 0.31% 0.30% 0.29% 0.26% 0.21% 0.18% 0.16% 0.13% 0.15% 0.14% 0.15% 0.14% 0.15% 0.14% 0.14% 0.14% 0.13% 0.12% 0.11% 0.09% 0.10% 0.10% 0.10% 0.09% 0.09% 0.08% 0.08% 0.08% 0.08% 0.08% 0.08% 0.07% 0.08% 0.08% 0.08% 0.08% 0.10% 0.11% 0.12% 0.13% 0.14% 0.16% 0.18% 0.18% 0.21% 0.22% 0.24% 0.24% 0.25% 0.27% 0.27% 0.29% 0.30% 0.32% 0.33% 0.32% 0.37% 5.86% 24.64% 2.57% 2.19% 13.4% 0.0180 19.0% 0.0359 14.2% Rm - Rf -6.78% 7.39% 0.30% -2.76% -1.30% -6.56% -8.36% 1.65% 7.46% 0.70% -1.62% -2.06% 3.61% -6.21% -0.89% -7.27% -7.94% 0.51% -11.01% 8.66% 5.76% -5.99% -2.73% -1.59% 0.87% 8.14% 5.17% 1.18% 1.68% 1.87% -1.14% 5.58% 0.80% 5.16% 1.76% 1.32% -1.59% -1.65% 1.29% 1.86% -3.40% 0.30% 0.96% 1.39% 3.90% 3.24% -2.62% 1.93% -1.98% -2.11% 2.94% -0.09% 3.47% -1.18% 0.54% -1.96% 3.48% -0.28% 2.31% -0.05% 0.87% 0.3% RA - Rf -4.94% 8.37% 0.66% -2.77% -2.18% -4.07% -7.72% 1.83% 5.73% 1.81% -1.33% -1.58% 4.81% -5.43% -0.83% -8.41% -7.18% 0.66% -10.21% 6.79% 4.00% -5.11% -2.22% -1.60% 1.56% 6.76% 5.04% 1.02% 1.87% 2.29% -0.30% 5.48% 1.40% 4.15% 2.16% 2.27% -0.94% -2.30% 1.80% 2.42% -4.03% -0.30% 1.30% 1.82% 5.06% 3.07% -2.90% 2.40% -0.79% -2.29% 3.60% 0.42% 3.90% -0.99% 1.69% -2.31% 4.45% 0.51% 3.82% -0.27% 0.63% RB - Rf -1.54% 1.00% -7.50% 3.36% 2.40% 13.14% -2.39% 2.25% 4.02% 9.91% 1.11% -0.69% -1.01% 3.41% -1.77% 7.32% -2.24% 3.26% -0.46% 2.68% 4.82% -5.82% 5.79% -6.32% 1.68% 3.15% 10.43% 1.00% -17.10% 1.69% 13.11% 12.72% 3.74% 4.43% 8.21% 7.67% 4.01% -9.30% 1.27% -2.04% 8.02% -2.97% 1.04% 0.48% 6.25% 0.28% 1.00% 9.10% -1.30% -4.04% -0.29% 5.07% 2.52% -1.42% 6.82% 2.55% 5.64% -4.52% 0.84% 1.92% -5.42% 0.36% 3.59% 21.99% 14.2% 13.4% 19.0% 0.98 0.180 0.16 0.924 0.211 0.177 0.004 A= U= Weight A Weight B Return 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 24.64% 22.76% 20.88% 19.00% 17.13% 15.25% 13.37% 11.49% 9.62% 7.74% 5.86% Standard Deviation 22.00% 18.96% 17.35% 15.86% 14.53% 13.41% 12.54% 11.99% 11.80% 11.99% 12.54% 13.40% 5.00% Sharpe 1.18 1.19 1.18 1.16 1.11 1.04 0.93 0.79 0.62 0.44 0.27 10 9.0% Indifference curve Exp Rtn 33.2% 27.0% 24.1% 21.6% 19.6% 18.0% 16.9% 16.2% 16.0% 16.2% 16.9% 18.0% 10.3% Portfolio Exce ss Ret urn Portfolio A -4.50% 8.75% 1.03% -2.45% -1.87% -3.77% -7.43% 2.09% 5.94% 1.99% -1.18% -1.45% 4.95% -5.28% -0.68% -8.26% -7.03% 0.80% -10.07% 6.93% 4.13% -4.99% -2.11% -1.51% 1.66% 6.85% 5.13% 1.11% 1.96% 2.37% -0.23% 5.56% 1.48% 4.23% 2.24% 2.34% -0.86% -2.23% 1.88% 2.50% -3.94% -0.19% 1.42% 1.96% 5.21% 3.23% -2.72% 2.57% -0.58% -2.07% 3.84% 0.66% 4.16% -0.72% 1.96% -2.02% 4.75% 0.83% 4.15% 0.04% 1.00% -15.00% Portfolio A 10.00% f(x) = 0.9244320912x + 0.0026366757 R = 0.9593619003 5.00% -10.00% -5.00% 0.00% 0.00% U = E(r) - A s2 7.71% Beta = y-int = 5.00% 10.00% 0.924 0.26% 0.211 1.79% RA - Rf Linear (RA Rf) -10.00% -15.00% Market Excess Ret urn -15.00% Portfolio B 15.00% 10.00% 5.00% f(x) = 0.2106444063x + 0.0179481846 R = 0.0248655623 0.00% -10.00% -5.00% 0.00% -5.00% -10.00% -15.00% Market Excess Ret urn -20.00% Utility Beta = y-int = -5.00% Portfolio Excess Ret urn Mar 01 Apr 01 May 01 Jun 01 Jul 01 Aug 01 Sep 01 Oct 01 Nov 01 Dec 01 Jan 02 Feb 02 Mar 02 Apr 02 May 02 Jun 02 Jul 02 Aug 02 Sep 02 Oct 02 Nov 02 Dec 02 Jan 03 Feb 03 Mar 03 Apr 03 May 03 Jun 03 Jul 03 Aug 03 Sep 03 Oct 03 Nov 03 Dec 03 Jan 04 Feb 04 Mar 04 Apr 04 May 04 Jun 04 Jul 04 Aug 04 Sep 04 Oct 04 Nov 04 Dec 04 Jan 05 Feb 05 Mar 05 Apr 05 May 05 Jun 05 Jul 05 Aug 05 Sep 05 Oct 05 Nov 05 Dec 05 Jan-06 Feb-06 Mar-06 Annualized Return Annualized Volatility 5.00% 10.00% RB - Rf Linear (RB Rf) 9= x-.5*10*SD^2 y Expected Return 10.25% 11.81% 14.00% 16.81% 20.25% 24.31% 29.00% 34.31% 40.25% E(rp) = x Standard Deviation 5.00% 7.50% 10.00% 12.50% 15.00% 17.50% 20.00% 22.50% 25.00% .09+.5*10*SD^2 45.00% Indifference Curve 40.00% CAL 35.00% 30.00% Optimal Complete Portfolio A=10 y(maxU) = 68.31% Allocation to Optimal Risky Portfolio 31.69% Allocation to Risk Free 25.00% E(r) Utility Oppurtunity Set 20.00% Optimal Complete Portfolio 15.00% 10.00% 5.00% rf 0.00% 0.00% 5.00% 10.00% 15.00% SD 20.00% 25.00% 30.00% PORTFOLIO A SUMMARY OUTPUT Regression Statistics Multiple R 0.979314426 R Square 0.959056744 Adjusted R Square 0.958362791 Standard Error 0.007895572 Observations 61 ANOVA df Regression Residual Total Intercept S&P 500 1 59 60 SS MS F Significance F 0.0861551341 0.0861551341 1382.0187635 1.210120E-042 0.0036780636 6.23401E-005 0.0898331977 Coefficients Standard Error t Stat P-value 0.002770946 0.0010135887 2.7337977622 0.0082516103 0.92527212 0.0248892899 37.175512955 1.21012E-042 Lower 95% Upper 95% Lower 95.0% Upper 95.0% 0.0007427602 0.004799133 0.00074276 0.0047991326 0.8754687657 0.975075474 0.875468766 0.9750754739 PORTFOLIO B SUMMARY OUTPUT Regression Statistics Multiple R 0.153532021 R Square 0.023572081 Adjusted R Square 0.007022456 Standard Error 0.054540862 Observations 61 ANOVA df Regression Residual Total Intercept S&P 500 1 59 60 SS MS F Significance F 0.004236954 0.004236954 1.4243271578 0.2374693975 0.1755076326 0.0029747056 0.1797445866 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% 0.019392716 0.0070016457 2.7697368207 0.0074885434 0.0053824552 0.033402976 0.005382455 0.0334029764 0.205189801 0.1719296952 1.1934517828 0.2374693975 -0.1388407242 0.549220327 -0.138840724 0.5492203266