Reference no: EM132796598
Question - You are currently holding portfolio M. You are considering combining M with se- curity X, Y, or Z. There are three possible scenarios listed in the table below. (For instance, in scenario 1 which happens with 20% probability, M will deliver a return of -20%).
Scenarios 1 2 3
Probability 20% 50% 30%
Return of M -20% 0% 30%
Return of X -10% 0% 15%
Return of Y 5% 5% 5%
Return of Z 5% 0% -5%
(a) Which of X, Y, and Z is a risk-free security when considered on a standalone basis?
(b) Now, you are considering investing 90% in your current portfolio M and investing 10% into X, Y, or Z. Suppose your goal is only to reduce portfolio risk and you do not care about portfolio return. Which of X, Y, or Z will you choose, and why?
c) Recall that you can short securities in forming your new portfolio. Is it possible to reduce portfolio risk by combining M and X by choosing appropriate portfolio weights? If so, please give examples of such portfolio weights.
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