CHAPTER 06
EFFICIENT DIVERSIFICATION
5. Impact on total variance
a. Both will have the same impact. The total variance will increase from .1714 to .
1921
b. An increase in beta, however, increases the correlation coefficient and thus
creates more diversification benefit.
8. The parameters of the opportunity set are:
E(rS) = 18%, E(rB) = 9%, S = 38%, B = 32%, = 0.13, rf = 4.8%
From the standard deviations and the correlation coefficient we generate the covariance
matrix [note that Cov(rS, rB) = SB]:
Bonds
Stocks
Bonds
1024.0
158
Stocks
158
1444
w Min (S)
2B Cov(rS , rB )
S2 2B 2Cov(rS , rB )
1024 158
0.4024
1444 1024 ( 2 158)
wMin(B) = 0.5976
The mean and standard deviation of the minimum variance portfolio are:
E(rMin) = (0.4024 18%) + (0.5976 9%) 12.62%
Min w S2 S2 w 2B 2B 2w S w B Cov(rS , rB )
6-1
% in stocks
% in bonds
Exp. return
Std dev.
9.00
00.00
100.00
23.00*
20.00
80.00
10.20
20.37*
40.24
59.76
12.62
25.99
Minimum variance
40.00
60.00
11.40
20.18*
60.00
40.00
12.60
22.50*
76.36
23.64
15.87
30.92
Tangency portfolio
80.00
20.00
13.80
26.68*
100.00
00.00
15.00
32.00*
*except for the minimum variance and the tangency portfolio, the yellow highlighted
answer are wrong, they were based on previous version.
9.
25.99%
30.92%
15.87 4.8
0.3581
30.92
6-2
11.
a. The equation for the CAL is:
E (rC ) r f
E (rp ) r f
C 4.8 0.3581 C
Rate of Return
100%
-50%
6-4