Question

1. The risky portfolio A consists of 1000 shares of BIT PLC and 4000 shares of DIMO PLC. Assume that BIT PLC has a share price of $6, an expected return of 18%, and a standard deviation of 22%. DIMO PLC has a share price of $4, an expected return of 14%, and a standard deviation of 20%. The correlation between the two is 0.6, and the risk-free rate of interest is 8%.

Required

1. Graph the Capital Allocation Line derived from the risk-free asset and portfolio A. (Label all axes and points carefully).

2. What fraction of your portfolio must you invest in A to have a portfolio standard deviation of 12%?

Answer 1

	Expected Return of BIT PLC=R1	18%
	Expected Return of DIMO PLC=R2	14%
	S1=Standard Deviation of BIT PLC	22.00%
	S2=Standard Deviation of DIMO PLC	20.00%
	Variance of BIT PLC=V1=(S1^2)	484.0	%%
	Variance of Stock DIMO PLC=V2(S2^2)	400.00	%%
	Correlation	0.60
	Covariance(1,2)=Correlation*S1*S2	264.00	%%
	Investment in BIT PLC=1000*6	6000.00
	Investment in DIMO PLC=4000*4	16000.00
	Total Investment	22000.00
	w1=Investment in BIT PLC=6000/22000	0.27272727
	w2=Investment in DIMO PLC=16000/22000	0.72727273
	Portfolio Return=Rp(Percentage)
	w1*R1+w2*R2=w1*18+w2*14=	15.09%
	Vp=Portfolio Variance=(w1^2)*V1+(w2^2)*V2+2*w1*w2*Cov(1,2)	352.2975207	%%
	Vp=Portfolio Variance=(w1^2)*484+(w2^2)*400+528*w1*w2=
	Sp=Portfolio Standard Deviation=Square root of Variance=SQRT(Vp)	18.77%
		Rf=Risk free Rate=8%
	PORTFOLIO A Return	15.09%
	PORTFOLIO A Standard Deviation	18.77%
	Risk Free Asset Return	8.00%
	Risk Free Asset Standard Deviation	0.00%
	New Portfolio(P) Return=w1*15.09+w2*8
	New Portfolio(P) Variance=(w1^2)*(18.77^2)		Covariance=0
	New Portfolio(P) Standard Deviation= Square Root (VariancE=e)
	ALL POSSIBLE PORTFOLIOS
		w1	w2	RP=w1*15.09+w2*8	VP=(w1^2)*352.2975	SP=Square Root(Vp)
		Weight of	Weight of
		Portfolio A	Risk Free Asset	New Portfolio Return(%)	Portfolio Variance(%%)	Portfolio Standard Deviation	Portfolio Return
		0	1	8	0.0000	0.00%	8.00%
		0.1	0.9	8.709	3.5230	1.88%	8.71%