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Frane Ltd has available two investment opportunities with the following risk return characteristics
A B
Expected return 13% 20%
Risk 4% 8%
Frane Ltd plans to invest 65% of its available funds in Security A, and 35% in B. The directors believe that the correlation coefficient between the returns of the securities is +0.2.
(i) Calculate the expected return of the portfolio and the risk of the portfolio.
(ii) Suppose the correlation coefficient between A and B was -1.0. How should Frane Ltd invest its funds in order to obtain a zero risk portfolio?
(iii) According to CAPM, "The only risk that matters to an investor is non-diversifiable risk." Do you agree with the comment? Discuss.
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