You have been bequeathed a legacy of £100,000 and you are considering placing the entire funds either in shares of company A or in shares in company B.
When you told your stock broker about this plan he suggested two alternative investment approaches.
a. Invest some of the money in A and some in B to give you at least a small degree of diversification. The proportions suggested are given in Table 2 below.
b. Invest the entire sum in a broad range of investments to reduce risk. This portfolio is expected to produce a return of 23 per cent per year with a standard deviation of 6 per cent.
To assist your final decision the broker provides you with forecasts by expert City analysts for shares in A and B given various states of the economy - see Table 1.
Table 1

Table 2

Required
a. Compare the risk and return of the alternatives (including your original intention of putting all the money into either A or B).
b. Display the results on graph paper and draw an estimated portfolio risk-return line based on the plot points for the two-share portfolio. (There is no requirement to calculate the minimum risk portfolio.)
c. Describe the efficient and inefficient region.
d. Use indifference curves to select the optimal portfolio to give the highest utility assuming that you are highly risk averse.

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State of the economy Probability of that state of the economy Returns on B Returns on A (9%) Recession Growth Boom 0.25 0.50 0.25 10 20 30 15 Portfolio Proportion of portfolio invested in A (%) roportion of portfolio invested in B (%) 25 75 90 75 25 10