Question

Suppose there are 2 funds ABC and XTP. ABC has an expected return of 7.5%. Portfolio MOR invests 30% in ABC and 70% in XTP. MOR has an expected return of 14.5%. What is the expected return to XTP? What is XTP's expected future price in three years' time assuming that it currently trades at £125? (a) (10 marks) (b) Suppose portfolio MOR has a standard deviation of 20.96% and ABC has a standard deviation of 15.0% and XTP has a standard deviation of 26.5%. What is the correlation coefficient between ABC and XTP? (10 marks) (c) Suppose the correlation coefficient between ABC and XTP changes to 0.65. Explain the impact this would have on portfolio risk. (10 marks) (d) Discuss, with diagrams as appropriate, how risk preferences impact the choice of portfolio in the case when there are only risky assets available.

Answer 1

A). Expected return of portfolio (MOR) = 14.5%

Expected return of ABC =7.5%

Let Expected return of XTP = x

14.5% = 7.5% *30%+ x * 70

By solving x, we get value x= 3%(Approx)

B)

Correlation R_xy = S_xy / S_xS_y

By putting figures , we get correlation = 5.374