3. You are evaluating various investment opportunities currently available and you have calculated expected returns and standard deviations for five different well-diversified portfolios of risky assets:
Portfolio Expected Return Standard Deviation
Q 7.8% 10.5%
R 10.0 14.0
S 4.6 5.0
T 11.7 18.5
U 6.2 7.5
a. For each portfolio, calculate the risk premium per unit of risk that you expect to receive ([E(R) − RFR]/σ). Assume that the risk-free rate is 3.0 percent.
b. Using your computations in Part a, explain which of these five portfolios is most likely to
be the market portfolio. Use your calculations to draw the capital market line (CML).
c. If you are only willing to make an investment with σ = 7.0%, is it possible for you to
earn a return of 7.0 percent?
d. What is the minimum level of risk that would be necessary for an investment to earn
7.0 percent? What is the composition of the portfolio along the CML that will generate
that expected return?
e. Suppose you are now willing to make an investment with σ = 18.2%. What would be
the investment proportions in the riskless asset and the market portfolio for this portfolio? What is the expected return for this portfolio?
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