Question

Suppose that securities are priced according to the CAPM. You have forecast the correlation coefficient between the rate of return on the High Value Mutual Fund (HVMF) and the market portfolio (M) at 0.8. Your forecasts of the standard deviations of the rate of return are 0.25 for HVFF and 0.20 for M. How would you combine the HVMF and a risk free security to obtain a portfolio with a beta of 1.6? Suppose that rf = 0.10 and E[rm ]= 0.15. If you were willing to tolerate the same risk as in the above portfolio, how much additional return could you obtain if your portfolio were efficient?

Answer 1

Answer i Fund beta = 7x sdcs) Sở (m) - 0.8%0.25 0.20 T 0,8x0.25 = 1 0.8x0.25 LŌ.20 =1. Since risk free Security has zero beta, in older to Obtain pootfolio bela as 106 , total money invested in HVFF will be combination of own money + shoot Selling of risk foee Securities. Ratio ob Short Sell oney to own money will be 60%. Additional money earned = (0.15-0.10)* 016 = 3% = (0.15-0.10) x 0.6 = 36%