Question

a) Discuss and analyse any four of the assumptions around Markowitz portfolio theory.

b) Consider a portfolio that consist of 2 assets with the following characteristics:

Asset	Expected Return	Standard Deviation	Correlation
A	20%	10%
B	40%	20%
A&B			-1

Compute the asset weights (WA and WB) so that an investor obtains a zero risk portfolio. Also

compute the expected portfolio return in this case.

Answer 1

Solution:-

Markowitz portfolio theory-

This model helps us to select "Best Securities" from the Portfolio.

Process-

Step1 - Take all securities avalialble in Market and plot it in Market and plot it in Risk Return Graph.

Step2 - Select Efficient and Ineffieceint Security. Securities which lie on efficient Frontier are Efficient Securities and All other Securities are Inefficient.

Step3 - Now to select Best security out of Efficient Security.

Rule of Selection and Assumptions-

1. If Security have same Risk Then Select those security who has higher Return.

2. If Security have same Return Then Select those security who has lower Risk.

3.  If Security have Higher Return Then Select those security who has lower Risk.

4. If security have higher Risk and Higher Return then select that.

B.

To Calculate Weight of Assets-

Weight of Asset A =

Weight of Asset A =

Weight of Asset A = 0.6667

Weight of Asset B = 1 - Weight of Asset A

Weight of Asset B = 1 - 0.6667

Weight of Asset B = 0.3333

To Calculate Expected Return of Portfolio

Expected Return of Portfolio is weighted Average Return.

Expected Return of Portfolio = 0.6667 * 20 + 0.3333 * 40

Expected Return of Portfolio = 26.67%

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