E120

Homework 10 Solutions
1. We set up the following three equations with three unknowns rX , rY , rM .
(a) rX = 0.05 + 1.5(rM 0.05)
(b) rY = 0.05 + 2.0(rM 0.05)
(c) rY = 1.10 rX
Solving yields rX =

1
,r
14 Y

11
,r
140 M

9
.
140

Since rP = r0 + P (rM r0 ) = 0.05 + 0.70

9
140

0.05 = 0.06.

2. Denote our stocks as A and B, we then have

(a) rA = r0 + 1.38(rM r0 )
(b) rB = r0 +?(rM r0 )
(c) r0 = r0 + 0(rM r0 )
(d) Since we invest equally in the three assets, the expected return of our portfolio
must satisfy:
rP = 31 rA + 13 rB + 31 r0 .
So that by combining the first three equations, we obtain:
rP = r0 + 13 (1.38+? + 0)(rM r0 ).
Given P = 1, we have 1.38+? + 0 = 3 = ? = 1.62.
3. (a)

1
2

16% + 12 4.8% = 10.4%.

(b) Let wA and wB denote weights, with wA + w0 = 1, and rP = wA rA + w0 r0 =

r0 + (wA 1.35 + w0 0)(rM r0 ).
So that wA 1.35 = 0.95 = wA = 0.703, w0 = 0.296.
(c) Now wA rA + w0 r0 = wA 16% + w0 4.8% = 8%, and wA + w0 = 1.
Together, this implies wA = 72 , w0 = 57 = P = 27 1.35 = 0.3857.
(d) wA 1.35 + w0 0 = 2.70 = wA = 2 = w0 = 1.
Borrow from the bank, then invest twice of what you have in asset A.
4. (a) From the security market line, we obtain the following two equations with two
unknowns rM and r0 :
0.12 = r0 + 0.8 (rM r0 )
0.15 = r0 + 1.2 (rM r0 )
Solving gives rM =

27
,
200

and r0 =

3
.
50

(b) See above.

(c)
1
1
1
P = A + B = (0.8 + 1.2) = 1
2
2
2
That is, this portfolio has the same beta as the market portfolio.