1. ## Help please fast!! Portfolio theory

1. Mr B. Shrewd has recently inherited £350,000 and is looking at ways to invest the money.

He is aware of portfolio theory and the importance of the market portfolio. From his research he discovers the following:

Security
expected return
standard deviation

Market portfolio
12%
3%

Share A
10%
4%

Share B
13%
6%

Share C
17%
6.5%

Risk free
4.5%
0%
(a) If Mr Shrewd is prepared to accept risk equivalent to a standard deviation of 6% how should he invest his money? What will the expected return of his investment be?

2. Originally Posted by little_nina
1. Mr B. Shrewd has recently inherited £350,000 and is looking at ways to invest the money.

He is aware of portfolio theory and the importance of the market portfolio. From his research he discovers the following:

Security

expected return

standard deviation

Market portfolio

12%

3%

Share A

10%

4%

Share B

13%

6%

Share C

17%

6.5%

Risk free

4.5%

0%

(a) If Mr Shrewd is prepared to accept risk equivalent to a standard deviation of 6% how should he invest his money? What will the expected return of his investment be?
If I'm reading this right, you want to maximise the % return while keeping standard deviation at 6%. It looks to me then like you want a combination of Market portfolio and Share C ....

In which case you should solve the following two equations to get the required proportion of each investment:

$\displaystyle \alpha (6.5) + \beta (3) = 6$ .... (1)

$\displaystyle \alpha + \beta = 1$ .... (2)

Do this and then calculate the expected return. I get an expected return of approximately 16.3%.

3. ye thats how i did it origionally. and got the same return. but i was wondering if there is a synergy effect. for example if you invest in two shares then the risk is reduced because you are diversifying? but then i dont know if there is a formula to work that out. I think i will probably just go with that though

Than you