Given that the risk-free rate is 5%, the expected return on the market portfolio is 20%,...
Given that the risk-free rate is 5%, the expected return on the market portfolio is 20%, and the standard deviation of returns to the market portfolio is 20%, answer the following questions: c. Now suppose that you want to have a portfolio, which pays 25% expected return. What is the weight in the risk free asset and in the market portfolio? d. What do these weights mean: What are you doing with the risk free asset and what are you doing with the market portfolio? e. What is the standard deviation of the portfolio in e? f. What is your conclusion about the effect of leverage on the risk of the portfolio?
Homework Answers
| Return | Std dev | |||||
| Risk free asset | 5% | 0% | ||||
| Market return | 20% | 20% | ||||
| Let weight of market return is x and weight in risk free asset is 1-x | ||||||
| 20x+5*(1-x) = 25 | ||||||
| x = | 20/15 | |||||
| x = | 1.333 | |||||
| 1-x= | -0.333 | |||||
| Weight in risk free asset = | -0.333 | |||||
| These weights mean that we are borrowing at the risk free rate | ||||||
| And investing in the market portfolio from funds borrowed at risk free rate | ||||||
| Std dev of portfolio | 26.67% | |||||
| The risk of the portfolio would increase based on leverage | ||||||
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