1. Why is the separation principle still valid in a world with
a) Nonmarketable assets?
b) A non stochastic risk-free rate?
2. Assume that the mean-variance opportunity set is constructed from only two risky assets, A and B. Their variance-covariance matrix is given below:
Asset A has an expected return of 30%, and asset B has an expected return of 20%. Answer the following questions:
a) Suppose investor I chooses his "market portfolio" to consist of 75% in asset A and 25% in asset B, whereas investor J chooses a different "market portfolio" with 50% in asset A and 50% in asset B.
Given these facts, what /3 will each investor calculate for asset A? b) Given your answer to part (a) above, which of the following is true and why?
1. Investor I will require a higher rate of return on asset A than will investor J.
2. They will both require the same return on asset A.
3. Investor J will require a higher rate of return on asset A than will investor I.
c) Compute the zero-beta portfolios and the equations for the security market line for each investor.