Answer:
Invest 50% in portfolio A and the rest 50% in risk-free asset to create Portfolio D, we will have the same systematic risk as that of Portfolio B.
The expected return of Portfolio D = 11%
Portfolio D and Portfolio B have the same beta of 1.0. But, portfolio D has a higher return of 11% as compared to the expected return of Portfolio B of 8%.
Buy Portfolio D, and sell Portfolio B.
Explanation:
A risk free asset is referred to an asset that provides a virtually guaranteed return and no possibility of loss.
Risk-free asset has a beta of 0.
Portfolio D Beta = Wa × Portfolio A Beta + Wb × Risk-free asset beta
1.0 = Wa * 2.0 + Wb * 0
Wa = 1.0/2.0
Wa = 0.50
If we invest 50% in portfolio A and the rest 50% in risk-free asset to create Portfolio D, we will have the same systematic risk as that of Portfolio B.
The expected return of Portfolio D = 0.50 × 0.19 + 0.50 ×0.03
The expected return of Portfolio D = 0.11
The expected return of Portfolio D = 11%
Portfolio D and Portfolio B have the same beta of 1.0. But, portfolio D has a higher return of 11% as compared to the expected return of Portfolio B of 8%.
Buy Portfolio D, and sell Portfolio B.
