Question

Evaluate the following investments, and explain the “best” choice among Portfolios A, B, and C, assuming that borrowing and lending at a risk-free rate of ?? = 3 percent is possible. Portfolio A: ?(?? ) = 13% , ?(?? ) = 15%

Portfolio B: ?(??) = 10% , ?(??) = 8%

Portfolio C: ?(?? ) = 11% , ?(?? ) = 14%

Answer 1

The best nethod is to calculate the sharpe ratio of all the stocks and compare the excess retun of the stock that is over the risk free return and the standard deviation of all the stocks.

Sharpe Ratio = (Return of portfolio - Risk Free return) / Risk (Standard Deviation)

So, For Portfolio A

Sharpe Ratio = (13% - 3%) / 15%

= 10% / 15%

= 0.667

So, For Portfolio B

Sharpe Ratio = (10% - 3%) / 8%

= 7% / 8%

= 0.875

So, For Portfolio C

Sharpe Ratio = (11% - 3%) / 14%

= 8% / 14%

= 0.5714

As we can see that the ratio is highest for the Portfolio B, so the best choice will be the portfolio B.