Question 1

Given data
σp Expected return of risky portfolio (rp)
Risk Free Asset 0% 6%
Risky Asset 28% 16%
Borrowing Rate 8%

CAL
18%
16%
14%
12%
Expected Return

10%
8%
6%
4%
2%
0%
0% 5% 10% 15% 20% 25%
Standard Deviation
 20% 25% 30%
on
 Question 2 & 3

Given data
σp
Risk Free Asset 0%
Risky Asset 28%
Borrowing Rate

Y (Portfolio allocation) E(rc) (Expected return of complete portfolio)

0 6%
0.1 7%
0.2 8%
0.3 9%
0.4 10%
0.5 11%
0.6 12%
0.7 13%
0.8 14%
0.9 15%
1 16%
1.5 21%
Question 2
a)The intuitive meaning of the reward to volatility ratio is that it represents the amount of potential reward an investor can
each unit of risk they are taking on. A higher ratio indicates that the potential reward is greater relative to the amount of ris
taken on, while a lower ratio indicates the opposite.
b)The reward to volatility ratio is a property of the efficient frontier, which represents the most efficient way to allocate cap
different assets. As long as the assets being considered are part of the efficient frontier, the reward to volatility ratio will rem
constant regardless of changes in expected returns and volatility.
Question 3
a) The reason why the lending and borrowing rates are different is because the broker needs to make a profit. Th
borrow money from other sources, such as banks or other financial institutions, at a lower rate than they lend to
investor, thus making a profit on the spread between the lending and borrowing rates.
b) There is a link between the CAL and the borrowing/lending rates because the borrowing and lending rates affe
free rate of return. The risk-free rate is the return an investor can earn on a risk-free asset, such as a government
risk-free rate is used as a baseline for calculating the expected return of a portfolio of risky assets.

CAL
25% Question 4
Y (Portfolio allocation) 20%E(rc) (Expected return of complete portfolio)
0 6%
Expected Return

15%

10%
 25%

20%

Expected Return
0.1
15% 7%
0.2 8%
0.3
10% 9%
0.4 10%
0.5 11%
5%
0.6 12%
0.7 13%
0%
0.8 14%
0% 5% 10% 15% 20% 25% 30% 35% 40%
0.9 15%
Standard Deviation
1 16%
1.5 21%
n2&3

Expected return of risky portfolio (rp)

6%
16%
8%

σc (Standard deviation of complete portfolio) Sharp Ratio (S)

0%
3% 35.7%
6% 35.7%
8% 35.7%
11% 35.7%
14% 35.7%
17% 35.7%
20% 35.7%
22% 35.7%
25% 35.7%
28% 35.7%
42% 31.0%

it represents the amount of potential reward an investor can expect for

at the potential reward is greater relative to the amount of risk being

ontier, which represents the most efficient way to allocate capital between
rt of the efficient frontier, the reward to volatility ratio will remain
ity.

ifferent is because the broker needs to make a profit. The broker can
er financial institutions, at a lower rate than they lend to the
lending and borrowing rates.
nding rates because the borrowing and lending rates affect the risk-
estor can earn on a risk-free asset, such as a government bond. The
ected return of a portfolio of risky assets.

The optimum complete portfolio is at E(r)=16%

CAL Standard deviation = 28%
tion 4
A
σc (Standard deviation of complete portfolio) Sharp Ratio (S) 3
0% 6.00%
 3% 35.7% 6.88%
6% 35.7% 7.53%
8% 35.7% 7.94%
11% 35.7% 8.12%
14% 35.7% 8.06%
17% 35.7% 7.77%
20% 35.7% 7.24%
% 20% 25% 30% 35% 22%
40% 45% 35.7% 6.47%
25% 35.7% 5.47%
Standard Deviation
28% 35.7% 4.24%
42% 31.0% -5.46%
o is at E(r)=16%

A
4
6.00%
 6.84%
7.37%
7.59%
7.49%
7.08%
6.36%
5.32%
3.96%
2.30%
0.32%
-14.28%
 Question 4

Risk Free Asset

Risky Asset
Borrowing Rate

Y (Portfolio allocation)
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
1.5

Y (Portfolio allocation) E(rc) (Expected return of complete portfolio)

0 6%
0.1 7%
0.2 8%
0.3 9%
0.4 10%
0.5 11%
0.6 12%
0.7 13%
0.8 14%
0.9 15%
1 16%
1.5 21%

Utility curve of Investors

Investor A=3 Investor A=4
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
Utility

0.00%
-2.00% 0 0.2 0.4 0.6 0.8 1
-4.00%
-6.00%
-8.00%
-10.00%
 6.00%
4.00%
2.00%

Utility
0.00%
0 0.2 0.4 0.6 0.8 1
-2.00%
-4.00%
-6.00%
-8.00%
-10.00%
Allocation to risky assets
Question 4
σp Expected return of risky portfolio (rp)
0% 6%
28% 16%
8%

E(rc) (Expected return of complete portfolio) σc (Standard deviation of complete port

6% 0%
7% 3%
8% 6%
9% 8%
10% 11%
11% 14%
12% 17%
13% 20%
14% 22%
15% 25%
16% 28%
21% 42%

σc (Standard deviation of complete portfolio) Sharp Ratio (S)

0%
3% 35.7%
6% 35.7%
8% 35.7%
11% 35.7%
14% 35.7%
17% 35.7%
20% 35.7%
22% 35.7%
25% 35.7%
28% 35.7%
42% 31.0%

Utility curve of Investors

Investor A=3 Investor A=4

0.6 0.8 1 1.2 1.4 1.6

0.6 0.8 1 1.2 1.4 1.6

Allocation to risky assets

Sharp Ratio (S)

35.7%
35.7%
35.7%
35.7%
35.7%
35.7%
35.7%
35.7%
35.7%
35.7%
31.0%

3 4
6.00% 6.00%
6.88% 6.84%
7.53% 7.37%
7.94% 7.59%
8.12% 7.49%
8.06% 7.08%
7.77% 6.36%
7.24% 5.32%
6.47% 3.96%
5.47% 2.30%
4.24% 0.32%
-5.46% -14.28%

Question 4
The key takeaway from this is that while making investment selections, investors should take
into account an investment's volatility or risk in addition to its predicted return. Because it
delivers a larger expected return relative to its risk, an investment option with a higher reward-
to-volatility ratio is more appealing. Hence, when choosing investment possibilities, investors
should try to maximise their reward-to-volatility ratio. Because the risk and expected returns
for investors are the same, the sharp ratio—which is 35.7% for both investors—will also be the
same.

1.6
 same.

1.6
a
 s, investors should take
ed return. Because it
tion with a higher reward-
nt possibilities, investors
sk and expected returns
nvestors—will also be the
 Question 5
U 11%
A 4
U 8%
σc (U=11%,A=4) (U=8%,A=4)
0% 11.00% 8.00%
3% 11.16% 8.16%
6% 11.63% 8.63%
8% 12.41% 9.41%
11% 13.51% 10.51%
14% 14.92% 11.92%
17% 16.64% 13.64%
20% 18.68% 15.68%
22% 21.04% 18.04%
25% 23.70% 20.70%
28% 26.68% 23.68%
42% 46.28% 43.28%

Indifference Curves

0.5
0.45
0.4
0.35
0.3
0.25
0.2
0.15
This is the tangent
point and investor Ac-
0.0999999999999999 tive portfolio

0.0499999999999999
-1.11022302462516E-16
0% 5% 10% 15% 20% 25% 30% 35%

(U=8%,A=4) (U=11%,A=4) (U=11%,A=3) (U=8%,A=3) C

 U 11%
A 3
U 8%
(U=11%,A=3) (U=8%,A=3)
11.00% 8.00%
11.12% 8.12%
11.47% 8.47%
12.06% 9.06%
12.88% 9.88%
13.94% 10.94%
15.23% 12.23%
16.76% 13.76%
18.53% 15.53%
20.53% 17.53%
22.76% 19.76%
37.46% 34.46%

This is the tangent

point and investor Ac-
tive portfolio

% 30% 35% 40% 45%

(U=8%,A=3) CAl
a