Problem: A portfolio that combines the risk-free asset and the market portfolio has an expected return of 22% and a standard deviation of 5%. The risk-free rate is 4.9% and the expected return on the market portfolio is 19%. Assume the capital-asset-pricing model holds. What expected rate of return would a security earn if it had a 0.6 correlation with the market portfolio and a standard deviation of 3%?
Q1. Without showing mathematical calculations, explain in writing how you would solve the problem.
Q2. What financial concept or principle is the problem asking you to solve?
Q3. In the context of the problem scenario, what are some business decisions that a manager would be able to make after solving the problem?
Q4. Is there any additional information missing from the problem that would enhance the decision-making process?