Explore BrainMass
Share

Explore BrainMass

    Market Portfolio

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    Your investment portfolio consists of $15,000 invested in one one stock - Microsoft. Suppose the risk-free rate is 5%. Microsoft stock has an expeted return of 12% and a volatility of 40%, and the market portfolio has an expected return of 10% and a volatility of 18%. Under the CAPM assumptions:

    a. What alternative investment has the lowest possible volatilty while having the same expected return as Microsoft?
    b. What investment has the highest possible expected return while having the same volatility as Microsoft?

    © BrainMass Inc. brainmass.com April 3, 2020, 8:07 pm ad1c9bdddf
    https://brainmass.com/economics/investments/299670

    Solution Preview

    Please see the attached file:
    Efficiency of the Market Portfolio
    Your investment portfolio consists of $15,000 invested in one one stock - Microsoft.  Suppose the risk-free rate is 5%.  Microsoft stock has an expected return of 12% and a volatility of 40%, and the market portfolio has an expected return of 10% and a volatility of 18%.  Under the CAPM assumptions:

    a.  What alternative investment has the lowest possible volatility while having the same expected return as Microsoft?

    The equation for the capital market line (CML) is
    return on efficient portfolio = risk free rate + (return on market portfolio-risk free rate ) x ( volatility of portfolio / volatility of market portfolio)
    or rp= rf + (rm-rf) x ( σp/ σm)

    return on efficient portfolio = x * return on market portfolio + (1-x) * risk free rate
    or rp= x rm + (1-x) rf

    volatility of efficient portfolio = x * volatility of market portfolio
    or σp=x ...

    Solution Summary

    Under the CAPM assumptions finds:
    1) investment that has the lowest possible volatilty while having the same expected return
    2) investment that has the highest possible expected return while having the same volatility

    $2.19

    ADVERTISEMENT