Question 5 (20 marks)

Based on current dividend yields and expected capital gains, the expected return on portfolios A and B are 11% and 14% respectively. The beta of A is 0.8 while that of B is 1.5. The rate of exchange fund bill is currently 6%, while the expected return of the Hang Seng Index is 12%. The standard deviation of portfolio A is 10%, while that of B is 31%, and that of the index is 20%. a. If you currently hold the Hang Seng Index, would you choose to add portfolio A or B to your holdings? (6 marks)

b. If you currently hold the exchange fund bills, which one would you choose (i.e. portfolio A, portfolio B or the Hang Seng Index) to add to your holdings? (8 marks) c. What would happen if we measure the performance of a poorly diversified portfolio using Treynor measure?