QUESTION ONE (30 marks)

An investor is considering an investment and has been provided the following information by the broker in respect to these three securities.

A

B

C

Expected return

16

18

15

Standard deviation

12

14

13

The correlation coefficient between security A and B=0.7, security B and C=0.4, security A and C=0.5. Assume that the investor will construct one of the following portfolios with the following characteristics:

Portfolio X consist of 60% investment in security A and 40% investment in security B

Portfolio Y consist of 40% investment in security A, 35% investment in security B and 25% investment in security C.

Required

a)

Calculate the expected return of each portfolio

(4 marks)

b)

Compute the covariance between the returns of various possible combinations

of the securities

(6 marks)

c)

Determine the standard deviation of each portfolio

(6 marks)

1

d) Compute the coefficient of variation and state which portfolio would you recommend to the investors? (5 marks) e) Explain the role investor's risk tolerance, age and investment horizon when constructing an investment portfolio (9 marks)