Reference no: EM133081816

In a market, there are the two risk-bearing assets share A and share B as well as the opportunity to risk-freely invest their money in the bank where both the deposit rate and the lending rate are 2.04%. The expected return and standard deviation for share A, share B, the market portfolio and the minimum variance portfolio are presented in the table below, and the correlation between share A and share B is equal to 0.

Expected return A=15,14
Expected return B=8,48
Expected return The market portfolio =11,01
Expected return Minimum variance portfolio=10,38
Standard deviation A=22,85
Standard deviation B=12,88
Standard deviation=10,29
Standard deviation=9,92

a) Sketch portfolio possibility curve and capital market line for the economy. Mark out the two shares, the risk-free asset, the market portfolio, the effective front and the minimum variance portfolio.

b)You do not trust the bank and therefore want to invest in a portfolio that only contains the two shares and are considering weighting your portfolio so that you have a holding of 15% in share A and 85% in share B. Is it a good or a bad idea to fold the portfolio that way? Justify your answer and illustrate it in a diagram.

c)If the standard deviation for share A was instead 12.88, ie the same as the standard deviation for share B. If only CAPM had an effective portfolio, it would have wanted to invest part of its assets in share B as it has the same standard deviation but lower expected return than share A? Justify your answer and illustrate it in a diagram.