Task 2:

You are managing an equal-weighted portfolio of stocks on behalf of your companys

treasury. Assume thatstock A and stock B are two risky assets. C is a risk-free asset.

The details of these stocks are below:

Stock A

Stock B

C (Risk-free asset r

f)

Average return

7.00%

15.00%

2.00%

Variance of return

0.0064

0.0196

Sigma of return

8.00%

14.00%

Covariance of returns

0.0011

Required

Using the information in the above stated table calculate the following:

a.

Expected

market portfolio return, E(RM)

W

A

X E(R

A

) + W

B

X E(R

B

)

=0.5 x 0.07 + 0.5 x 0.15 = 0.11 = 11%

b.

Market excess return

= Expected Retun Risk Free

=11% - 2% = 9%

c.

The Sharpe ratio

= Market Excess Return / Portfolio Std Dev

Portfolio Std deviation = (0.5

2

X 0.07 + 0.5

2

X 0.15 + 2 (0.5) (0.5) 0.0011)

0.5

= 0.305040981 = 31%

Sharpe Ratio = 9% / 31% = 29.5%

Explain what information the Capital Market Line and the Security Market Line give and why

they are considered useful tools in portfolio management (250 words max