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CMA Final · Strategic Financial Management · Portfolio Theory and Practice

The risk-free rate is 6%. Portfolio M has an expected return of 14% and a standard deviation of 16%. An investor builds a portfolio with 25% in the risk-free asset and 75% in M, with no borrowing. What are the expected return and standard deviation of this portfolio?

The portfolio has an expected return of 12% and a standard deviation of 12%. Return is 0.25 x 6% + 0.75 x 14% = 12%. Risk is only 75% of M's 16% because the risk-free asset contributes no variance and no covariance.

  1. A11.0% and 12.0%
  2. B12.0% and 16.0%
  3. C12.0% and 12.0%Correct
  4. D14.0% and 12.0%

Explanation

Return = 0.25 x 6 + 0.75 x 14 = 1.5 + 10.5 = 12%. Risk = 0.75 x 16 = 12%, because the risk-free asset has zero standard deviation and zero covariance with M. The 12% and 16% option wrongly leaves the risk undiluted.

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