Question 1

In discussing with your financial advisor about your investment strategy, you mention that you would like to hold an efficient portfolio (E) offering a 10% expected return.

Based on his analysis, the market portfolio offers a 12% expected return with a risk, measured by the standard deviation, of 5% while the T-Bills (risk-free asset) offer a 4% return.

a) Determine the composition of the efficient portfolio E.

b) Calculate the beta of the efficient portfolio E. Verify that portfolio E offers a 10% expected return in equilibrium.

c) Calculate the risk (standard deviation) of the efficient portfolio E.

d) For an efficient portfolio such as E, would you advise measuring the risk by the beta or the standard deviation? Demonstrate and justify your answer.

e) In the case of an individual asset (and not a portfolio), would you advise measuring the risk by the beta or the standard deviation? Justify your answer.