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Question 3 (12 Marks) a) You have formed two portfolios and would like to assess their performance. As a starting point, you conducted excess-return index
Question 3 (12 Marks) a) You have formed two portfolios and would like to assess their performance. As a starting point, you conducted excess-return index model regressions using annual data, and obtained the following estimates: 1.6% +0.9(rm-1) (Portfolio A) 0.6% + 1.3(rm-ri) (Portfolio B) Additionally, you have established that the standard deviation of excess returns is 28% for Portfolio A, 22% for Portfolio B, and 20% for the market. The risk-free return is 2% p.a., and the excess market return is 5% p.a. Required: i. Calculate the Sharpe and Treynor measures for Portfolios A and B. Which portfolio would be the preferred choice according to each measure? In answering, also describe the conditions under which you would use either the Sharpe or Treynor measure, in assisting with your ultimate decision. (4 Marks) ii. Calculate the MP for Portfolio B. (2 Marks) ii. Draw a graph that shows the Capital Market Line (CML), and the Capital Allocation Line (CAL) for Portfolio B. Show the positions of all relevant portfolios and identify the M2 for Portfolio B on the graph. (2 Marks) b) Alpha Capital has invested 60% of its funds in shares, 35% in bonds, and 5% in cash. The return on the share component over the prior year was 7.28%, 1.89% for the bond component, and 0.48% for the cash component. You have identified appropriate benchmark weights reflective of a neutral allocation, which involves a 50% allocation to shares, 30% to bonds, and 20% to cash. The return on each of the benchmark components over the past year was 5.81% for shares, 1.45% for bonds, and 0.48% for cash. Required: Calculate the excess return for Alpha Capital, and the contribution due to asset allocation and security selection. (4 Marks)
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