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    UNSW FINS2624 Problem Set 5

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    joannamanngo
    This document outlines two problem sets involving portfolio analysis and the Capital Asset Pricing Model (CAPM). Problem set 1 involves calculating Sharpe ratios and using combinations of risky and risk-free assets to dominate other portfolios. Problem set 2 involves determining optimal portfolio weights using a utility function and accounting for different borrowing and lending rates. Problem set 3 applies the CAPM to a two-asset market, calculating betas, contributions to variance and return, and determining if a portfolio could beat the market based on these contributions.

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    UNSW FINS2624 Problem Set 5

    Uploaded by

    joannamanngo
    1K views2 pages
    This document outlines two problem sets involving portfolio analysis and the Capital Asset Pricing Model (CAPM). Problem set 1 involves calculating Sharpe ratios and using combinations of risky and risk-free assets to dominate other portfolios. Problem set 2 involves determining optimal portfolio weights using a utility function and accounting for different borrowing and lending rates. Problem set 3 applies the CAPM to a two-asset market, calculating betas, contributions to variance and return, and determining if a portfolio could beat the market based on these contributions.

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    UNSW FINS2624 problem set 5

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    This document outlines two problem sets involving portfolio analysis and the Capital Asset Pricing Model (CAPM). Problem set 1 involves calculating Sharpe ratios and using combinations of risky and risk-free assets to dominate other portfolios. Problem set 2 involves determining optimal portfolio weights using a utility function and accounting for different borrowing and lending rates. Problem set 3 applies the CAPM to a two-asset market, calculating betas, contributions to variance and return, and determining if a portfolio could beat the market based on these contributions.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    1K views2 pages

    UNSW FINS2624 Problem Set 5

    Uploaded by

    joannamanngo
    This document outlines two problem sets involving portfolio analysis and the Capital Asset Pricing Model (CAPM). Problem set 1 involves calculating Sharpe ratios and using combinations of risky and risk-free assets to dominate other portfolios. Problem set 2 involves determining optimal portfolio weights using a utility function and accounting for different borrowing and lending rates. Problem set 3 applies the CAPM to a two-asset market, calculating betas, contributions to variance and return, and determining if a portfolio could beat the market based on these contributions.

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    © All Rights Reserved
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    of 2

    PROBLEM SET 5

    1) The risk free rate is 4% and the following data is given about assets X and
    Z:
    Asset
    X
    Z

    E(r)
    7%
    16%

    20%
    30%

    (a) What are the Sharpe ratios of the two risky assets?
    (b) Show how you can dominate asset X using a portfolio that combines
    asset Z and the risk free asset.
    (c) Show how you can dominate a portfolio with equal weights in asset X
    and the risk-free asset using a portfolio that combines asset Z and the
    risk free asset.
    (d) Show (in general) how you can dominate any portfolio combining asset
    X and the risk-free asset using a portfolio that combines asset Z and
    the risk-free asset.
    2) Suppose that the risk-free rate is 3% and that the optimal risky portfolio
    has an expected return of 15% and a standard deviation of 20%. Consider
    an investor with preferences represented by the utility function
    U = E(r) 12 2 2 .
    (a) What fraction of her wealth should she invest in the risky portfolio?
    (b) Now suppose that the investor faces a higher risk-free rate when borrowing. Specifically, the investor may lend at a risk-free rate of 3% but
    borrow at a risk-free rate of 5%. Assume for simplicity that the optimal
    risky portfolio is not affected. What fraction of her wealth should the
    investor now put in the risky portfolio?
    (c) What is the expected return and standard deviation of the portfolio
    that you found in (b)?

    3) Consider a market that consists of only two assets, A and B. The riskfree rate, rf , is 3% and the expected return of the market, E(rM ), is 13%.
    Some properties of the individual assets are given in the table below (with
    denoting the corrleation coefficient and w denoting the assets weight in
    the market portfolio):
    Asset
    A
    B

    w
    0.4
    0.6

    2
    0.04
    0.25

    0.2
    0.5

    i,A
    1
    0.3

    i,B
    0.3
    1

    (a) What is the market variance?


    (b) What are the covariances with the market of the two assets?
    (c) Recall the CAPM equation we derived at the end of lecture 5:
    E(ri ) = rf +

    Cov(ri , rM )
    [E(rM ) rf ]
    2
    M

    We typically refer to the risk measure i =

    Cov(ri , rM )
    2
    M

    as the assets (CAPM) . What are the CAPM of the two assets?
    (d) What is the CAPM of the market portfolio?
    (e) What are the reward-to-risk ratios of the two assets?
    (f) What are the contributions of each asset to the market excess return,
    E(rM ) rf ?
    2
    ?
    (g) What are the contributions of each asset to the market variance, M

    (h) What are the contributions of each asset to the reward-to-risk ratio of
    E(rM ) rf
    the market,
    ?
    2
    M
    (i) Suppose you had found that the contribution of asset A to reward-torisk ratio of the market was 1 and that the contribution of asset B to
    the same ratio was 0.8. How could you construct a portfolio that beats
    the market? Could this be an equilibrium?

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