You manage a risky portfolio with an expected rate of return of 18% and a standard deviation of 28%. The T-bill rate is 8%. 10. Draw the CML and your fund's CAL on an expected return-standard deviation diagram.

PART 1 Your client's degree of risk aversion is A=3.5.

a. What proportion (y) of the total investment should be invested in your fund?

b. What is the expected value and standard deviation of the rate of return on your

client's optimized portfolio?

Your estimate that a passive portfolio (i.e., one invested in a risky portfolio that mimics that S&P/TSX Composite index) yields an expected rate of return of 13 percent with a standard deviation of 25 percent. Continue to assume that rf = 8 percent.

PART 2 Draw the CML and your fund's CAL on an expected return-standard deviation diagram.

a. What is the slope of CML?

b. Characterize in one short paragraph the advantage(s) of your fund over the passive

fund.

PART 3Your client ponders whether to switch the 70 percent that is invested in your fund to the passive portfolio.

a. Explain to your client the disadvantage(s) of the switch.

b. Show your client the maximum fee you could charge (as a percentage of the

investment in your fund deducted at the end of the year) that would still leave him or her at least as well-off investing in your fund as in the passive one. (Hint: The fee will lower the slope of your client's CAL by reducing the expected return net of the fee.)

PART 4 Consider the client in problem PART 1 with A=3.5.

a. If the client chose to invest in the passive portfolio, what proportion (y) would be

selected?

b. Is the fee (percentage of the investment in your fund, deducted at the end of the year)

that you can charge to make the client indifferent between your fund and the passive strategy affected by her capital allocation decision?