50.1K

Verified Solution

Link Copied!

Kay, a portfolio manager at KD Asset Management, focuses on stock selection in her strategy. Her firm does not allow short-selling. She receives the following forecasts based on private information from her research associates:

	Forecast Return	Standard Deviation	Beta	Return Residuals Std. Dev.
Stock x	14%	36%	0.9	40%
Stock y	16%	25%	1.1	20%
Stock Z	13%	25%	1.5	30%
Market Index	14%	15%	1.0

risk free interest rate = 3%

1. Given this private information and ability to pick mispriced stocks, determine the composition of the optimal risky portfolio (P) for Kay to hold using the Treynor-Black model, assuming her current portfolio mimics the market index. Show all computations.

2. Calculate the Sharpe ratio of the optimal risky portfolio, P, managed by Kay and compare it to that of the market index portfolio. Show your computations.

3. If Kays client is risk averse with a coefficient of risk aversion of 4 (i.e., A=4), compute the exact makeup of the complete portfolio of the client (C), i.e., specify the percentage of funds that should be invested in each stock, the market index portfolio, and the risk-free asset. Show all computations.

4. Based on the results you obtained above, graph and label the old and new investment opportunity sets as well as the optimal risky portfolio (P), active portfolio (A), market index portfolio (M), Kays client portfolio (C), and the risk-free rate (r_f) for full credit.

Answer & Explanation Solved by verified expert

See Answer