Exam 2

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  1. (30 points) Assume that the CAPM holds. Consider the possibility of forming a portfolio out of three assets: (1) risk-free asset, (2) a risky stock, and (3) and index fund that buys the market portfolio. The expected rate of returns and standard deviations are:
    MATH

    1. Assume that the investor wants a return of 8%. What is the minimum amount of risk that the investor must bear?

    2. Suppose we want to form an efficient portfolio that has an expected rate of return of 16%. Explain how you would construct this portfolio.

    3. Does the problem contain enough information to determine the beta on stock A? If so, what is it? If not, what additional information would you need?

  2. (40 points) Suppose we have two risky assets, A and B. The expected return and standard deviation of these two assets are: $r_{A}=0.95\%,$ $r_{B}=1.19\%,$ MATH MATH The correlation of A and B is 0.65%.

    1. Form a portfolio consisting of assets A and B. Plot the efficient frontier curve.

    2. Calculate the minimum variance portfolio.

    3. Assume that a risk-free rate is available, and it is 0.68%. How does the analysis change? Derive the capital market line (CML).

    4. How would you incorporate a preference function into the analysis? How will be preference function relate to the efficient frontier? Now the investor's utility function is
      MATH
      What is the optimal portfolio combination?

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