Capital Markets, Investment and Finance Tutorial 4

In Utopia, a very restrictive investment market exists. Investors are able to invest in four
types of security in any combination! "#,$,C and %. &ecurities #,$ and C are all risky
investments and t'eir current market derived expected returns (r! and t'e standard
deviation of t'ese returns )! are *iven belo+ :
Security E(r)
# ,.-, ,.,.
$ ,.-/ ,.,4
C ,.., ,.,0
#ll are perfectly positively correlated +it' eac' ot'er. &ecurity % is a risk1free
investment +'ic' yields a period return of 23. Investors can also borro+ unlimited
amounts of cas' at an interest rate of 23 per period. T'ere is no taxation in Utopia444
Required
a! 5ra+ to scale t'e area of possible risky portfolio. 5ra+ t'e Capital market
6ine and identify t'e market portfolio.
b! Calculate t'e market price of risk and explain +'at it means.
c! &tate briefly +'at conclusions you dra+ from your ans+er to a! about t'e
current state of t'e market for risky assets in Utopia.
d! #n investor in Utopia +is'es to 'old an efficient portfolio yieldin* a -,3
expected period return. 7o+ +ould t'is portfolio be composed and +'at
+ould its risk be8
e! &'o+ 'o+ an investor in utopia mi*'t construct an efficient portfolio yieldin*
a .,3 expected period return.
f! &tate t'e main assumptions underlyin* portfolio t'eory and indicate briefly
+'y its conclusions may be of importance for investment decision makin*
+it'in individual companies.