Question
Jeremy has $10k USD to invest and would like to hear your suggestions. You have provided him a complete portfolio investment plan. The complete portfolio
Jeremy has $10k USD to invest and would like to hear your suggestions. You have provided him a complete portfolio investment plan. The complete portfolio is composed by a risky portfolio with return of 10.5% and standard-deviation of 15%, and a risk-free asset with return equals to X% (X is the third-digital number of your student ID. Say you have a student ID of 278123A, and the risk-free rate of return is then 8%. If the third-digital number is 0, then rf is 0). After comparison between these two choices, Jeremy prefers the risk-free option.
a), Determine the minimum value of Jeremy's risk-aversion factor. Keep 3 decimals in your answer. [2 marks]
b), Using the minimum value of the risk-aversion factor you derived from 1) and the information from the question, calculate the optimal weighting for Risk-free and risky portfolio. Keep 3 decimals in your answer. [1 marks]
c), Using the weighting you derived from 2) and the information from the question, calculate Jeremy's complete portfolio return and risk. Keep three decimals in your answer. [1 mark]
d), Peter would like to invest in the U.S share market. Consider the following table, which gives a security analysts expected return on two stocks in two particular scenarios for the rate of return on the market:
Market Return | Aggressive Stock | Defensive Stock |
6% | -3% | 8% |
22% | 40% | 11% |
The probability of the pessimistic (optimistic) scenario is 90% (10%) and the risk-free rate is 3%. What is the equation of SML and the alphas for the aggressive and defensive stock? Please keep 2 decimals in your answer. [5 marks]
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