Risk, Return and diversification

Jayne wants to invest her money to meet a liability of $12,000.00 six months from now. She can pick between portfolios A and B and a risk free asset that returns 1% p.a. annually compounded. Information on Assets A and B can be found in the table below.

	Beta	Standard deviation
A	1.1	17%
B	1.2	27%

a) What are CAPM expected returns for portfolios A and B? Assume market expected rate of return is 7% p.a. annually compounded.

b) Jayne wants her investment to have an annual volatility not higher than 25% while maximizing the return. Combining portfolios A and B with the risk free rate (but not between each other), create two alternative strategies for her to invest in. What are expected returns of these portfolios?

c) Which portfolio would you suggest her to invest in?

d) Given the portfolio you selected in c), how much should Jayne invest today to have enough money to meet the liability six months from now?

e) Assuming CAPM holds, how do you explain the fact that the 2 investment portfolios you created have differing returns while having identical volatilities?