Reference no: EM132572716
Suppose we have two risky assets, Stock I and Stock J, and a risk-free asset. Stock I has an expected return of 25% and a beta of 1.5. Stock J has an expected return of 20% and a beta of 0.8. The risk-free asset's return is 5%.
a. Calculate the expected returns and betas on portfolios with x% invested in Stock I and the rest invested in the risk-free asset, where x% = 0%, 50%, 100%, and 150%.
b. Using the four portfolio betas calculated in part (a), reverse engineer (i.e., derive mathematically) the portfolio weights for a portfolio consisting of only Stock J and the risk-free asset.
c. Calculate the reward-to-risk ratios for Stock I and Stock J.
Hint: For example, if we wished to obtain a portfolio beta of 0.5, then the weights on Stock J and the risk-free asset must be 62.5% and 37.5%, respectively, and the expected return for this portfolio must be 14.375%.