Question

The market index has average return 7% and standard deviation
30%. The

risk-free rate is 3%. A portfolio has beta 1.4, unsystematic
variance of 0.03,

and an M2-measure of -0.01. What is the average return on the
portfolio?

Answer #1

Total Variance of the portfolio= Beta^2*market variance + unsystematic variance

= 1.4^2*0.3^2+0.03

**= 0.2064**

Standard deviation of the portfolio = 0.2064^0.5 = 0.4543
**or 45.43%**

M2 = (return of portfolio (R) - risk free rate) * standard deviation of market/ standard deviation of portfolio - (Return on market - risk free rate)

= (R-0.03)*0.3/0.4543 - (0.07-0.03) = -0.01

=> (R-0.03) = 0.03*0.4543/0.3 = 0.04543

R = 0.07543 or **7.543%**

**So, average return on the portfolio is
7.543%**

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Standard Deviation
Risk Free Rate
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Market Index Return
Market Index Std. Deviation
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2%
5%
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22%
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Paragraph

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