Question

For the following questions, assume that you manage a risky portfolio with an expected rate of return of 18% and a standard deviation of 26%. The T-bill rate is 7%.

Answer 1

Solution 3:

Given,
Expected rate of return of the risky portfolio, E(r) =	15%
Standard deviation of the portfolio, Std. Dev.=	25%
Risk free rate, RFR =	5%

CAL Diagram:

CAL Expected Return 0% 5% 10% 10% 15% 20% 25% 30% Standard deviation

a) Slope of the CAL = (E(R)-RFR)/Std. Dev. = (15%-5%)/25% = 0.40

b) Given, Coefficient of risk aversion = 5
Utility score of investment = E(r) -( 0.5*Coefficient of risk aversion*Std. dev^2) = -0.625%
This means that by subtracting the investor aversion adjusted portfolio risk there is a risk equivalent return that generates even lower return than the risk-free rate of 5%.
So, it is not advised to invest in the risky portfolio.