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The expected return of portfolio A is 16% and portfolio B is 25%. Their standard deviations...

The expected return of portfolio A is 16% and portfolio B is 25%. Their standard deviations are 21% (portfolio A ) and 30% (portfolio B). If the risk-free rate is 4%, which portfolio is the “dominant “. Show the concept (and formula) used to define dominance and all calculations.

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Answer #1

Sharpe ratio is the concept to determine the dominance of the security. It shows the returns per unit of risk taken.

Sharpe ratio = [ Return on portfolio - Risk free rate ] / Standard Deviation

Sharpe ratio A= [ 16% - 4% ] / 21

                  = 12 / 21

                  = 0.5714

Sharpe ratio B = [ 25% - 4% ] / 30%

                      = 21 / 30

                      = 0.70

Portfolio B is dominant over portfolio A.

Sharpe ratio portfolio A =

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