Modern portfolio theory (20 marks)

1. The following tables outline the information for 3 risky assets.

	A	B	C
Expected return E(R) %	16%	12%	16%
Risk ( %)	7%	7%	10%

Return correlation coefficient :

	A	B	C
A	1	-0.15	-0.35
B	-0.15	1	0.3
C	-0.35	0.3	1

Required:

1. If you are only allowed to pick one asset for investment, which asset will you prefer as a rational investor? Explain your reason(s). (3 marks)
2. If you want to construct an equally-weighted investment portfolio with the 3 risky assets, calculate the portfolios expected rate of return and standard deviation of returns (7 marks)

2. If an equity fund manager believes the Australian stock market will begin to drift downwards over the next year, how might the manager fine-tune his/her equity portfolio to help safeguard investors wealth under his/her management? Assume that the fund only invests in equities. (3 marks)

3. Assume BHP shares beta is 0.75, the 12-month risk-free rate of return is 5% p.a and the market risk premium is 6% p.a. Outline a strategy for a rational investor if BHPs shares are presently priced to achieve a 10% p.a. expected rate of return. (7 marks)