CMA Final · Strategic Financial Management · Portfolio Theory and Practice
The risk-free rate is 6%, the expected return on the market portfolio is 14% and its standard deviation is 15%. Meera has ₹10 lakh of her own funds and borrows another ₹5 lakh at the risk-free rate, investing the entire ₹15 lakh in the market portfolio. What are the expected return and standard deviation on her own funds?
Meera's weights are 150% in the market and −50% in the risk-free asset. Expected return is 1.5×14 − 0.5×6 = 18%, and standard deviation is 1.5×15 = 22.5%. Ignoring the borrowing cost would wrongly give 21%.
- A21.0% and 22.5%
- B18.0% and 15.0%
- C18.0% and 22.5%Correct
- D17.0% and 7.5%
Explanation
Weight in market = 15/10 = 1.5 and weight in risk-free = −0.5. Return = 1.5×14 − 0.5×6 = 21 − 3 = 18%. Standard deviation = 1.5×15 = 22.5%, as the borrowing carries no risk. The 21% option ignores the cost of borrowing.
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