You estimate that a passive portfolio, that is, one invested in a risky portfolio that mimics the S&P 500 stock index, yields an expected rate of return of 13% with a standard deviation of 25%. You manage an active port- folio with expected return 18% and standard deviation 28%. The risk-free rate is 8%. a) Calculate and interpret the return of the P* portfolio
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
4. You estimate that a passive portfolio, that is, one invested in a risky portfolio that mimics the S&P 500 stock index, yields an expected
a) Calculate and interpret the return of the P* portfolio
b) Draw the CML and your funds’ CAL on an expected return–standard deviation diagram.
c) Explain in one short paragraph the advantage/disadvantage of your P* over the passive fund.
d) Your client ponders whether to switch the 70%of his wealth to the passive portfolio. Explain to your client the disadvantage/advantage of the switch.
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