Scribd
Upload
36 views2 pages

Topic 4 Tutorial Questions

1) The correlation coefficient between the returns of two risky assets must be less than 1 for there to be gains from diversification. A correlation of 1 means the assets move together perfectly so diversification provides no benefit. 2) When adding a risky asset to a portfolio, the asset's covariance with the other assets is more important than its standard deviation alone. Covariance measures how an asset's returns co-vary with the portfolio's existing assets. 3) Choosing different allocations to the optimal risky portfolio and risk-free asset would affect the Sharpe ratio of the complete portfolio, with higher Sharpe ratios indicating more efficient portfolios that generate more return for a given level of risk

Uploaded by

Thirusha balamurali
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
36 views2 pages

Topic 4 Tutorial Questions

1) The correlation coefficient between the returns of two risky assets must be less than 1 for there to be gains from diversification. A correlation of 1 means the assets move together perfectly so diversification provides no benefit. 2) When adding a risky asset to a portfolio, the asset's covariance with the other assets is more important than its standard deviation alone. Covariance measures how an asset's returns co-vary with the portfolio's existing assets. 3) Choosing different allocations to the optimal risky portfolio and risk-free asset would affect the Sharpe ratio of the complete portfolio, with higher Sharpe ratios indicating more efficient portfolios that generate more return for a given level of risk

Uploaded by

Thirusha balamurali
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 2

Tutorial 4:

Efficient diversification
1. In forming a portfolio of two risky assets, what must be true of the correlation
coefficient between their returns if there are to be gains from diversification?
Explain.

2. When adding a risky asset to a portfolio of many risky assets, which property of the
asset is more important, its standard deviation or its covariance with the other
assets? Explain.

3. Your client ponders various allocations to the optimal risky portfolio and risk-free
T-notes to construct his complete portfolio. How would the Sharpe ratio of the
complete portfolio be affected by this choice?

Use the following data to answer questions 4-8.

Your client is considering three managed funds. The first is a share fund, the second
is a long-term government and corporate bond fund and the third is a cash fund
that yields a sure rate of 5.5%. The probability distributions of the risky funds are:
Expected return Standard deviation

Share fund (S) 15% 32%


Bond fund (B) 9% 23%
The correlation between the fund returns is 0.15.

4. Tabulate and draw the investment opportunity set of the two risky funds. Use
investment proportions for the share fund of 0 to 100% in increments of 20%. What
expected return and standard deviation does your graph show for the minimum-
variance portfolio?

5. Draw a tangent from the risk-free rate to the opportunity set. What does your graph
show for the expected return and standard deviation of the optimal risky portfolio?

6. What is the reward-to-volatility ratio of the best feasible CAL?


7. Suppose now that your portfolio must yield an expected return of 12% and be
efficient, that is, on the best feasible CAL.

a. What is the standard deviation of your portfolio?

b. What is the proportion invested in the T-note fund and each of the two risky
funds?

8. If you were to use only the two risky funds and still require an expected return of
12%, what would the investment proportions of your portfolio be? Compare its
standard deviation to that of the optimal portfolio in question 7. What do you
conclude?

You might also like