PORTFOLIO ANALYSIS AND INVESTMENT
Suppose that investor A holds a portfolio (portfolio A) consisting of five shares. The portfolio return is equal to 10% while its risk (st.dev) equals 12%. The market portfolio (consisting of all n shares) at this point of reference rewards investors with 15% and its risk is equal to 10%.
a) Is this portfolio (portfolio A) an efficient one? Explain.
b) Suppose that the risk free interest rate is 2%. What is the diversification benefit of another investor (investor B) who holds a perfectly diversified portfolio (portfolio B) that embeds the same level of risk with that of portfolio A (i.e. s?=s?=12%)? Explain.
c) How this portfolio (portfolio B) can be constructed? Explain.
d) How does the existence of the risk free interest rate affect the optimum portfolio construction? Explain.