Suppose that securities are priced according to the CAPM. You have forecast the

Question

Suppose that securities are priced according to the CAPM. You have forecast the correlation coefficient between the rate of return on the High Value Mutual Fund (HVMF) and the market portfolio (M) at 0.8. Your forecasts of the standard deviations of the rate of return are 0.25 for HVFF and 0.20 for M. How would you combine the HVMF and a risk free security to obtain a portfolio with a beta of 1.6? Suppose that rf = 0.10 and E[rm ]= 0.15. If you were willing to tolerate the same risk as in the above portfolio, how much additional return could you obtain if your portfolio were efficient?

I need this answer fairly quickly if you guys can, thank you so much

Explanation / Answer

Solution: Beta of the portfolio = Coef. Of correlation * standard deviation of portfolio/standard deviation of market

=0.8*0.25/0.2

=1

Expected return on HVF portfolio = Rf + (Rm – Rf) = 0.10 + 1*(0.15-0.1)

=0.15

Mean return on desired portfolio = Rf + (Rp – Rf) = 0.1 + 1.6(0.15 – 0.1)

=0.18 or 18 %

Additional return is 8%

96%

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