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Assume analysts provide the following information. Assume short sales are allowed. Stock Expected Return Standard Deviation 1 12% 4% 2 10% 6% 3 9% 5%

Assume analysts provide the following information. Assume short sales are allowed.

Stock

Expected Return

Standard Deviation

1

12%

4%

2

10%

6%

3

9%

5%


Correlation Coefficients

Stock 1

Stock 2

Stock 3

Stock 1

1

0.75

0.5

Stock 2

1

-0.25

Stock 3

1

a) What is the optimum portfolio if the lending and borrowing rate is 4%? What are the expected return and the standard deviation of this optimal portfolio? (4 marks)

b) Simon claims that there is an efficient portfolio called Portfolio A having expected return 8% and standard deviation 4%. Draw the Capital Market Line and mark the positions of Portfolio A, Stock 1, 2, 3 and the optimum portfolio in (a). (4 marks)

c) Validate Simon's claim in question (b). (2 marks)

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a The optimal portfolio is a portfolio with the highest Sharpe ratio The Sharpe ratio is calculated by subtracting the riskfree rate from the expected ... blur-text-image

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