Question 3 - There are two risky assets in the market: portfolio X and portfolio Y. X has an expected return of 15% and standard deviation of 35%. The expected return and standard deviation for Y is 20% and 45% respectively. The correlation between the two portfolios is 0.2. The rate of risk-free asset, T-bill, is 5%. Assume the optimal risky portfolio P* is given by investing 50.48% in X and 49.52% in Y. a) Mary is your client and her risk aversion level A is 2 (assume U = E(r) - 0.5A0%). How do you advise Mary to allocate her money among risk-free asset, portfolio X, and portfolio Y? b) Suppose CAPM holds and the return of market portfolio is 17.48%, the beta of portfolio X turns out to be 0.9 and portfolio Y is in equilibrium, is portfolio X is fairly-priced, under- priced, or over-priced? c) Draw the Security Market Line (SML) and indicate the positions (label the coordinate clearly on the graph) of risk-free asset, portfolios X and Y, and the alpha of portfolio X on the graph. (22 marks) Question 3 - There are two risky assets in the market: portfolio X and portfolio Y. X has an expected return of 15% and standard deviation of 35%. The expected return and standard deviation for Y is 20% and 45% respectively. The correlation between the two portfolios is 0.2. The rate of risk-free asset, T-bill, is 5%. Assume the optimal risky portfolio P* is given by investing 50.48% in X and 49.52% in Y. a) Mary is your client and her risk aversion level A is 2 (assume U = E(r) - 0.5A0%). How do you advise Mary to allocate her money among risk-free asset, portfolio X, and portfolio Y? b) Suppose CAPM holds and the return of market portfolio is 17.48%, the beta of portfolio X turns out to be 0.9 and portfolio Y is in equilibrium, is portfolio X is fairly-priced, under- priced, or over-priced? c) Draw the Security Market Line (SML) and indicate the positions (label the coordinate clearly on the graph) of risk-free asset, portfolios X and Y, and the alpha of portfolio X on the graph. (22 marks)