Tangency portfolio associated with the given tangency line

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Reference no: EM131583665

Consider the following two portfolios on a tangency line:

• Portfolio 1 has 5.5% expected return and 15% return standard deviation.

• Portfolio 2 has 8.5% expected return and 25% return standard deviation. Throughout this problem, there are no restrictions on short-selling.

i) Compute the Sharpe ratio of the Tangency Portfolio associated with the given tangency line. (Hint: In an (x,y)-diagram, the slope of a straight line connecting points (x1,y1) and (x2,y2) is given by (y2-y1)/(x2-x1).)

ii) Compute the risk-free rate that is located on the given tangency line.(Hint: If you cannot solve part (a), use a Sharpe-ratio of 0.25.)

iii) Suppose that there is a second tangency line, corresponding to a riskfree rate of 2% and a market portfolio with 6% expected return and 20% return standard deviation. With the risk-free rate of 2%, what is the maximum expected return that you can generate given 25% return standard deviation?

iv) Given the usual --preferences, suppose you wanted to form a portfolio with 25% return standard deviation. Which of the two tangency lines would you prefer, the original tangency line or the second tangency line?

Reference no: EM131583665

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