Exceeding standard deviation they are able to tolerate

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Reference no: EM132029490

Assume that investors are maximizing the expected return subject to not exceeding standard deviation they are able to tolerate. There are 2 assets available for all investors. The first asset is the stock market which provides the expected return of 15% and has the standard deviation of 20%. The second asset is the bank account which pays the interest rate of 1%. The expected return of the second asset is 1%. The bank generates profits by borrowing to customers at a higher rate than the interest rate it is paying on their bank accounts, so the bank will only borrow you money at 5% rate. Derive the formula for the capital market line (expected return as a function of the standard deviation) and draw it (drawing approximately by hand is perfectly ok). Hint 1: Divide the capital market line in two parts: where you put money into the bank account and where you borrow.

Reference no: EM132029490

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