QUESTION THREE (25 marks)

Peter wants to build a portfolio using T-bills and an index fund that tracks the NSE-20-share market index. The index fund has an expected return of 16% and a standard deviation of 30%. T-bills have a return of 10%.

Required:

i)	Explain why T-bills are perceived to have a risk of zero	[ 3 marks]
ii)	Why are major stock market indices used as proxy for the market portfolio?
		[3 marks]
iii)	What are the homogeneous expectations of investors	[4 marks]

4. Why is the slope of the capital market line referred to as the Sharpe ratio? [3 marks]

5. If Peter invests 100% of his funds in T-bills, what is his expected return? [2 marks]

6. Suppose Peter invested 75% in the index fund and 25% in T-bills, estimate the

return and standard deviation of the portfolio formed

[4 marks]

vii) Using the available information, plot the capital market line [4 marks]

viii) From the graph in iv) above, determine the return and risk of a portfolio

consisting 50% investment in T-bills and 50% investment in the index fund [2 marks]