Question

We are dealing with an idyllic perfect market except that you are allowed to invest in only one of the following cooperative funds - in addition to, of course, the Lenin Treasury bill.  The expected value and the standard deviation of the cooperatives’ returns are given as follows:

                        Coop Funds                 A         B         C         D         E          F

                        Std. Dev.                     18        10        8         5         22        15

                        Exp. Return (%)            5          8        12        -2         17        15

a. Identify the set of efficient funds.

b. Which securities will everyone choose to invest in? Assume the Lenin T-bill is expected to yield 8%, and you can buy or short sell it.

c. Compute the portfolio composition and its risk level that yield a 16% rate of return on average.

Presently, you find out that you can buy Lenin T-bills at 10%.

d.  How does this affect your answer to (c)?

Answer 1

Coop Funds	A	B	C	D	E	F
Std. Dev. (Risk)	18	10	8	5	22	15
Exp. Return(%)	5	8	12	-2	17	15
Return/Risk	0.28	0.80	1.50	-0.40	0.77	1.00

To find out where one should invest, we find the ratio of return to risk. It tells us the proportion of returns expected to be earned per unit of risk. Higher the return to risk ratio higher are the chances of better returns and vice-versa.

Going by this concept, all stocks, except stock E, will give a positive return. Out of these, the most optimum stock is stock C as it has the highest Return to risk ratio.