Reference no: EM1374141
You are discussing your 401K with Dan Ervin, when he mentions that Sarah Brown, a representative from Bledsoe Financial Services is visiting East Coast Yachts today. You choose that you should meet with Sarah, so Dan sets up an appointment for you later in the day.
When you sit down with Sarah, she shows the various investment options available in the company's 401K account. You mention to Sarah that you researched East Coast Yachts before you accepted your new job. You are confident in management's ability to lead the company. Analysis of company has led to your belief that company is growing and will get a greater market share in the future. You also feel you could support your employer. Given these considerations, along with the fact that you are a conservative investor, you are leaning toward investing 100 percent of your 401K account in East Coast Yachts.
Imagine the risk-free rate is the historical average risk-free rate. The correlation between the bond fund and the large cap stock fund is .15. note that the spreadsheet graphing and solver functions can assist you in answering the subsequent questions.
1) Considering the effects of diversification, how could Sarah respond to suggestion that you invest 100 percent of your 401K account in East Coast Yachts stock?
2) After hearing Sarah's response to investing your 401K account entirely in East Coast Yachts stock, she has convinced you that this can't be the best alternative. Since you are a conservative investor, you tell Sarah that a 100 percent investment in the bond fund can be the best alternative, Is it?
3) Using the returns for the Bledsoe Large-Cap Stock Fund and the Bledsoe Bond Fund, graph opportunity set if feasible portfolios.
4) After examining the opportunity set, you notice that will invest in portfolio consisting of the bond fund and the large-cap stock fund that may have exactly the same standard deviation as the bond fund. This portfolio will also have a greater expected return. Find what the portfolio weights are and expected return of this portfolio?
5) Describing the opportunity set, notice there is a portfolio that has the lowest standard deviation. This is the minimum variance portfolio. Evaluate what are the portfolio weights, expected return, and standard deviation of this portfolio? Why is the minimum variance portfolio important?
6) A calculate of risk-adjusted performance that is usually used is the Sharpe ratio. The Sharpe ratio is determined as the risk premium of an asset divided by its standard deviation. The portfolio with the highest possible Sharpe ratio on the opportunity set is called the Sharpe optimal portfolio. Find what are portfolio weights, expected return, and standard deviation of the Sharpe optima portfolio? How does the Sharpe ratio of this portfolio compare to the Sharpe ratio of the bond fund and the large-cap stock fund? Do you see a connection between the Sharpe optimal portfolio and the CAPM and what is the connection?
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