Question
Dante has $1,000,000 to invest. He has a choice between investing his funds in an aggressive growth mutual fund (the risky portfolio) or investing his
Dante has $1,000,000 to invest. He has a choice between investing his funds in an aggressive growth mutual fund (the risky portfolio) or investing his funds in a money market mutual fund (the risk-free portfolio). The risky portfolio has an expected return of 18.5% [E(rp) = 0.185] and a standard deviation of 29% [p = 0.29]. The money market mutual fund has an expected return of 3% [rf = 0.03]. (a) Suppose Dante constructs an investment portfolio where 70% of his funds are invested in the risky portfolio and 30% of his funds are invested in the risk-free portfolio. Calculate the expected return E(rc) and standard deviation (c) of the overall portfolio. [3 Points] (b) Calculate the Sharpe ratio of the risky portfolio. Calculate the Sharpe ratio of the overall portfolio. [3 Points] (c) Draw the capital allocation line (CAL) for Dantes portfolio. What is the slope of the CAL? Show the position of Dantes overall portfolio on the CAL (label this point, A on your graph). [3 Points] (d) Suppose that Dante wants to create an overall portfolio consisting of a mixture of the risky portfolio and the risk-free portfolio that has an expected return of 15% [E(rc) = 0.15]. What proportion of his funds (y) must Dante invest in the risky portfolio in order to achieve the desired expected return of the overall portfolio? What would be the standard deviation of the overall portfolio? [4 Points] (e) Suppose instead that Dante wants to create an overall portfolio consisting of a mixture of the risky portfolio and the risk-free portfolio that has a standard deviation of 18% [c = 0.18]. What proportion of his funds (y) must Dante invest in the risky portfolio in order to achieve the desired standard deviation on the overall portfolio? What would be the expected return of the overall portfolio? [4 Points]
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