Question

Assume that investors can borrow and lend at risk-free rate of 5%. The optimal tangent portfolio on the efficient frontier has an expected return of 15%, and STD of 20%. John would like to construct his complete investment portfolio by allocating funds between the risk-free asset and the optimal tangent portfolio. Which of the following complete portfolios can John NOT achieve?
A. Portfolio A with E(R)=17.5% and STD=25%
B. Portfolio B with E(R)=13% and STD=18% c. Portfolio
C with E(R)=10% and STD=10% d. Portfolio
D with E(R)=5.5% and STD=1%
E. None of the above.

Answer 1

Answer:

B. Portfolio B with E(R)=13% and STD=18%

Explanation:

The computation is shown below;

Reward to risk ratio = (15% - 5%) ÷ 20% = 0.5

The porfolio should be in line i.e.

= 0.05 + 0.5 × standard deviation

For portfolio A

= 0.05 + 0.5 × 25

= 17.5%

For portfolio C

= 0.05 + 0.5 × 1

= 5.5%

Portfolio B, the std is 18%

So,

= 0.05 + 0.5 × 18%

= 14%