You are evaluating various investment

You are evaluating various investment

You are evaluating various investment opportunities currently
available and you have calculated expected returns and standard
deviations for five different well- diversified portfolios of risky
assets: Portfolio
Expected
Return
Standard
Deviation

Q
7.8%
10.5%

R
10.0
14.0

S
4.6
5.0

T
11.7
18.5

U
6.2
7.5

a. For each portfolio, calculate the risk premium per unit of
risk that you expect to receive ([ E( R) – RFR]/ s). Assume that
the risk- free rate is 3.0 percent.

b. Using your computations in Part a, explain which of these
five portfolios is most likely to be the market portfolio. Use your
calculations to draw the capital market line ( CML).

c. If you are only willing to make an investment with s = 7.0%,
is it possible for you to earn a return of 7.0 percent?

d. What is the minimum level of risk that would be necessary for
an investment to earn 7.0 percent? What is the composition of the
portfolio along the CML that will generate that expected
return?

e. Suppose you are now willing to make an investment with s =
18.2%. What would be the investment proportions in the riskless
asset and the market portfolio for this port-folio? What is the
expected return for this portfolio?

4. You are an analyst for a large public pension fund and you
have been assigned the task of evaluating two different external
portfolio managers ( Y and Z). You consider the following
historical average return, standard deviation, and CAPM beta
estimates for these two managers over the past five years:

Portfolio Actual Avg. Return Standard Deviation Beta

Manager Y 10.20% 12.00% 1.20

Manager Z 8.80 9.90 0.80

Additionally, your estimate for the risk premium for the market
portfolio is 5.00 percent and the risk- free rate is currently 4.50
percent.

a. For both Manager Y and Manager Z, calculate the expected
return using the CAPM. Express your answers to the nearest basis
point ( i. e., xx. xx%).

b. Calculate each fund manager’s average “ alpha” ( i. e.,
actual return minus expected return) over the five- year holding
period. Show graphically where these alpha statistics would plot on
the security market line ( SML).

c. Explain whether you can conclude from the information in Part
b if: ( 1) either man-ager outperformed the other on a risk-
adjusted basis, and ( 2) either manager outper-formed market
expectations in general.

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