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Confused on question 1 part d, don't know how to do it. Question (1) (Minimum Variance Frontier, E cient Portfolios and Optimal Portfolio Selection)(12 points)The
Confused on question 1 part d, don't know how to do it.
Question (1) (Minimum Variance Frontier, E cient Portfolios and Optimal Portfolio Selection)(12 points)The Triad family of mutual funds allows investors to split their money between three portfolios managedby Triad. Portfolio C has an expected return of E[Rc] = 10% and a standard deviation of returns of(Rc) = 15%. Portfolio B has an expected return of E[Rb] = 19% and a standard deviation of return of(Rb) = 25%. The correlation coe cient between the returns of portfolios B and C is b;c = 0:2. PortfolioA consists entirely of riskfree securities, and has a certain return of 4%: Your client is leaning towardsinvesting her money entirely in portfolio C, since she is unwilling to take the higher risk associated withportfolio B, but wants a higher return than oered by portfolio A.
(a) As a Triad investment advisor, you suggest to her an alternative portfolio P (consisting of a combinationof only portfolios A and B) that has the same expected return as portfolio C but a lowerstandard deviation. If she has $200,000 to invest, how much should she invest in B and how muchin A? What is the standard deviation of the return on her investment in this case? Sketch a meanstandard deviation diagram that you would use to explain why the portfolio you suggest is better.
(b) However, after your convincing presentation of the alternative portfolio P, your client now saysthat she is really comfortable with the level of risk in portfolio C. So, you suggest to her anotherportfolio P1 (also consisting of a combination of only portfolios A and B) that has the same standarddeviation as portfolio C, but higher expected return. If she has $200,000 to invest, how much shouldshe invest in B and how much in A? What is the expected return on her investment in this case?Sketch a mean standard deviation diagram that you would use to explain why the portfolio yousuggest is better.
(c) Your client also recalls reading a while ago in the 1st edition of "Investments" by Sharpe andAlexander (Je Bailey at the time she went to school was not a coauthor of this book), that peopleshould hold e cient portfolios, but she is unsure how to do it. She asks you for advice on how tooptimally combine portfolios C and B in order to take advantage of diversication. You suggest herto invest in a mix of the portfolio A and a so called mean-variance e cient portfolio (MVEP) whichis made up of portfolios B and C. Find this MVEP portfolio (i.e. nd the weights on portfolio Band C that generate the MVEP). Use Excels solver function to do this (feel free to use the ExampleOptimal CAL.xls that is posted on the course webpage). What is the expected return, standarddeviation and Sharpe ratio of the MVEP portfolio that you found?1
(d) Your client wants to keep the level of risk of her portfolio at the same level of portfolio C (i.e.standard deviation of 15%) but take advantage of diversication. If she invests $200,000 in A andMVEP, how much should she invest in portfolio A and how much in the MVEP ? How much in eachof the portfolios B and C? What is the expected return on her portfolio in this case ? Compare itto the expected return on P1 obtained in part (B) and explain the dierence, if any.
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