Task 1:
You are managing an equal-weighted portfolio of stocks on behalf of your company's treasury. Assume thatstock A and stock B are two risky assets. C is a risk-free asset.
The details of these stocks are below:
Stock A
Stock B
C (Risk-free asset r f) Average return
7.00%
15.00%
2.00%
Variance of return
0.0064
0.0196
Sigma of return
8.00%
14.00%
Covariance of returns
0.0011
Required
Using the information in the above stated table calculate the following:
a. Expected
market portfolio return, E(RM)
W A X E(R A) + WB X E(R B) =0.5 x 0.07 + 0.5 x 0.15 = 0.11 = 11%
b. Market excess return = Expected Retun - Risk Free =11% - 2% = 9%
c. The Sharpe ratio = Market Excess Return / Portfolio Std Dev
Portfolio Std deviation = (0.52 X 0.07 + 0.5 2 X 0.15 + 2 (0.5) (0.5) 0.0011) 0.5 = 0.305040981 = 31%
Sharpe Ratio = 9% / 31% = 29.5%
Explain what information the Capital Market Line and the Security Market Line give and why they are considered useful tools in portfolio management (250 words max)