Consider a 12 months potential investment in two securities. Security 1 has an expected return of 6% per annum and that of security 2 is 8% per annum. The standard deviation of the returns for security 1 9% and for security 2 it is 10%. The risk-free rate is 6.5% and the correlation between the two securities is 0.4.

Required:

1. Which combination of the two securities will result in expected returns that exceed the risk free rate?

[6 Marks]

2. What is the portfolio volatility for each of the combinations identified in (a) above?

[6 Marks]

3. Which of all the possible portfolios lie on the efficient frontier?

[8 Marks]

Total 20 M