 This topic has 4 replies, 3 voices, and was last updated Jan18 by simply_complex2.

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A portfolio has a riskadjusted expected rate of return of 18% over the course of the next year, in an environment with a risk free rate of 6%, and an expected market return of 12%. If the markets are expected to have a standard deviation of returns of 4.5%, what is the expected standard deviation of the actual portfolio?
 6.75%
 9%
 Covariance is required to solve this problem

Correct Answer: B
This problem is solved by multiplying the portfolio CML equation by the ratio of the portfolio standard deviation to market standard deviation. The equation is then rearranged and solved for the portfolio standard deviation. The trick is to remember that this market portfolio will have a beta of one, and that a market portfolio is solved for nonsystemic risk instead of beta. Similarly, covariance would only be required if we were solving for systemic risk, as would be accomplished for the SML equation rather than the CML. The calculation is as follows:


Not exactly. The way I think about it is that the portfolio is riskadjusted, meaning that (returns excess of risk free rate) / (std dev) of the market must equal that of the portfolio.
Hence to use @exam_whiz’s convention,
(ERp – Rf) / sdp = (ERm – rfr) / sdm
Which you can rearrange into what @exam_whiz shows in their answer.



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