Question

Assume the Sharpe ratio (slope) of the best feasible capital allocation line you can get by combining an optimal risky portfolio and a risk-free asset is 0.4. If the optimal risky portfolio has an expected return of 13% and a standard deviation of 26%, what should be the risk-free rate?

	A.	1.00%
	B.	2.60%
	C.	4.60%
	D.	8.84%
	E.	5.00%

Answer 1

Sharpe Ratio= ( Rp-Rf)/ Standard deviation of fund
Where
Rp= Return on fund
Rf= Risk Free Return
As given in question
Sharpe Ratio= 0.4
Rp= 13%
Standard Deviation= 26%
Using Above formula
Sharpe Ratio= ( Rp-Rf)/ Standard deviation of fund
0.4= ( 0.13 - Rf)/ 0.26
0.4 x 0.26= 0.13-Rf
0.104= 0.13-Rf
Rf= 0.13 - 0.104
Rf = 0.026
Rf = 2.60%
Therefore Answer would be B i.e Risk free rate would be 2.60 %