Question

Kiara is demanding clent her Account has been transferred to Dora to manage.Kiara feels that her portfolio is not "existing enough"and wants to take more risk.her current portfolio has expected return and volatility of 22.00% and 33.0% respectivly. dora's firm research department has portfolio that it consider optimal in a mean variance frame work.made up of two funds.the risk free rate of return is 5% the optimal risky portfolio has weight of 20% in growth fund and 80% in balance fund.

	Growth of equity fund	Balanced fixed Income fund
Expected return	18%	8%
Standard deviation	20%	5%
Correlation coeffiecient	- 0.21875

A) What is Expected Return of the optimal portfolio?

B)What is Standard Deviation of the optimal portfolio?

C) what is euation of capital allocation line in this example?

D)Kiara wishes to invest in fund with expected return is 22.00% and standard deviation of 45%,expalin Kiara that why this fund is not a good choice?

E)what portfolio would you recommend to get the same expected return?How risky thta portfolio will be?

F)A high risk averse Flexi ,wishes to invest all his money so that his maximum risk is 5% p.a.what portfolio will recommend to flexi.

Answer 1

A. Expected return of portfolio = 0.2*18% + 0.8*8% = 10%

B. Standard Deviation of portfolio = ( (0.2^2) *(0.2^2) + (0.8^2) * (0.05^2) + 2*0.2*0.8*0.2*0.05*(-0.21875))^0.5 = 0.05 = 5%

C. The equation of the capital allocation line = E(r) = 5 + ((10-5)/5)* = 8 +

D. Kiara's current portfolio gives her a return of 22% with a standard deviation of 33%. Investing in a portfolio with the same return but with a greater standard deviation means she is taking a greater unrewarded risk for the same return and hence it is not a wise decision.

E. For getting a return of 22% one should invest in the portfolio giving a standard deviation of 33%.

F. The optimal risk at a standard deviation of 5% would be to invest in a portfolio of equity and balanced fixed income giving 10% returns as shown above.