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Kindly assist me on this > Investment Management Inc. (IMI) uses the capital market line to make asset allocation recommendations.IMI derives the following forecasts:
• Expected return on the market portfolio:12%
• Standard deviation on the market portfolio:20%
• Risk free rate:5%
Samuel Johnson seek’s IMI’s advice for a portfolio asset allocation. Johnston informs IMI that he wants the standard deviation of the portfolio to equal half of the standard deviation for the market portfolio. Using the capital market line, what expected return can IMI provide subject to Johnson’s risk constraint?The answer is 8.5%. Beta = portfolio risk / market risk. So the required beta of the portfolio is 0.5. So the expected return = 5% + 0.5 (12 – 5) = 8.5%
BUT this cannot be asked in Paper F9. You can be required to use a beta to calculate a required return i.e. the last bit of my answer, but not the rest of this question.
YOU Currently own shares in Buckeye Mutual Fund (BMF). Your broker calls and recommends buying shares in a small-capitalization fund managed by Wolverine Investment Group (WIG). Your broker says that this fund will provide significant diversification benefits for your existing holdings. She gives you the following statistics based on the performance of the two funds over the last year.
(5 Marks)
Std. Dev.
14%
11%
20%
12%
a. Assume you can earn an average annual yield of 8% on a risk-free security. Which of these funds would be the optimal fund to combine with the risk-free security? Why?
b. Using the fund you selected in part (a), how much portfolio weights in the fund and the risk-free security would be required to earn a target return of 22%? Describe this position. (7 Marks)
Assume the covariance between the Buckeye and Wolverine funds is 0.00154. What would have been your average return and standard deviation over the last year if you placed 60% of your investment in Buckeye and 40% of your investment in Wolverine? (8 Marks)
Wolverine Investment Grp.
E(Return)
Portfolio
Buckeye Mutual Fund
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