Question Two (20 Marks)

As an investment analyst you have been presented with the following variance-covariance matrix and expected returns vector (for Safaricom and BAT Stocks respectively) for a two asset world to evaluate and advice accordingly:

• ^{. 020} , E (R_i) = (.22 .15)

0 . 0064

1. What is the expected return of a zero-beta portfolio, given that 50% of the index portfolio is

invested in Safaricom and the rest in BAT (1 Mark) b. Based on your answer above what other factors would you consider while forming a

minimum variance portfolio

(4 Marks)

c. What is the vector of weights in the minimum variance portfolio?

(1 Marks)

d. Based on (c) above discuss how macroeconomic and microeconomic factors will influences

the ultimate allocation decision (8 Marks)

5. Given decreasing marginal utility, it is possible to prove that in a mean-variance framework no individual will hold 100% of his or her wealth in in a risk free asset. Why?

(6 Marks)