You are advising a client to construct a portfolio worth £20 million. You’re considering constructing combining a risk-free asset with a portfolio of risky assets. Consider the data given and answer the subsequent questions:
American Express
(Amex) Coca-Cola
(Coca) The Gillet Company
(Gillet) T-Bills
Expected Return 16% 16.1% 17.6% 5%
Standard Deviation 29% 24.7% 27.3% 0%
Weights 32% 51% 17%
Correlations
Amex & Coca 0.61
Amex & Gillet 0.317
Coca & Gillet 0.548
a) Calculate the portfolio returns and standard deviation, if no investment is made in T-Bills. 05 Marks
b) Calculate the risk premium demanded by investors for buying one unit of risk.
05 Marks
c) If the target risk (standard deviation) is 15%; then what should be the weightage distribution between T-Bills and the portfolio. Also calculate the expected return of the combined portfolio for these weights.
05 Marks
d) Given your client’s target return is 25%; then what should be the weightage distribution between T-Bills and the portfolio. Do they need to borrow any money and if yes then how much they need to borrow? 05 Marks
e) Explain how Capital Allocation Line differs from and Capital Market Line.
05 Marks
