Question

Question 10 9 points) Consider the following plot of an investment opportunity set for all stocks in the market. Assume the CAPM holds for all parts below Elrl Standard Deviation (1) Draw the capital market line (CML) and label the market portfolio on this plot. (3pts) (2) Suppose investor A has a very high risk aversion and investor B has a very low risk aversion. Label investor A's complete combined portfolio as Ca and investor B's complete combined portfolio as CB. (Note these will be approximate.) (3pts) (3) Suppose everything about the stocks in the economy was the same, but we had new investors that all had much higher risk aversion. How would this plot change? You can describe in words or draw on the picture. (Hint: What will happen to the expected return on the market? What does that mean about the expected return for each the stocks in the investment opportunity set?) (3pts)

Answer 1

1 ) Capital Market Line is the level of the returns in the portfolio of the company based on the given rate of standard deviation co relation as below.

40% 35% 30% ER,)-27.5% 25% E(RM)-20% 15% ERB)-12.5% Portfolio B risk premium, 22,5% il Market risk premium, 15% Portfolio A risk premium, 7.5% 10% R7 5% 0% 20% SDM-10% so,-15% 0% SD,-5% Standard Deviation Financial Management Pro

2) As per the given condition in this question refer the above graph then for the given level of the risk the Mr A can be refered as the Portfolio A while the Mr B can be refered as teh portfolio B .

Risk has the direct relation with the Standerd deviation more the SD more will be the Risk.

3) For the purpose refer the graph given below... in the given diagram the amount of the returns from the market will change according to the risk (Standard deviation ). therefore the amount of return will increase with the increase of the Risk.