Question

You are the new investment manager of Bob and Eric. You received from the previous investment manager of Bob and Eric's partial information regarding their portfolios:

- Both have an optimal portfolio.

- The expected return in Bob's portfolio is 6%.

- The SD in Eric's portfolio is 12%.

You know that the current risk-free interest rate is 5% and the market portfolio has an expected return of 8% and a SD of 10%.

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1. What is the proportion of each brother’s investment in a risk-free asset out of their portfolio?

2. Is it possible to rank the brothers’ risk preferences? Explain.

3. What is the beta in each brother’s portfolio?

4. Suppose that today Bob and Eric received an offer to buy a share with an expected return of 6% and a beta of 0.3. Will they accept the offer? (Bob will accept / not accept the offer + Eric will accept / not accept the offer )

Answer 1

1.The combined portfolio's expected return is simple average of the expected return of the two individual portfolios Bob and Eric.(10%)

2.combined portfolio's beta is a simple average of the betas of the two individual portfolios (1.0)

3.The combined portfolio's standard deviation is less than a simple average of the two portfolios' standard deviations (25%), even though there is no correlation between the returns of the two portfolios

4.portfolio risk and return and beta 0.3 will they accept letter both.