Consider an economy where all stocks have been grouped into two indexes, the Hig
ID: 2613194 • Letter: C
Question
Consider an economy where all stocks have been grouped into two indexes, the High Flyer (HF) index and the Cash Cow (CC) index. The HF index has an expected excess return over cash of 12% and a standard deviation of 30%, and the CC index has an expected excess return over cash of 2% and a standard deviation of 10%. The two indexes are uncorrelated with one another. What are the weights in the global minimum-variance portfolio that combines the two indexes (but does not hold cash) in such a way as to minimize the variance of the portfolio return? What is the standard deviation of this portfolio return? Suppose the CAPM holds in this economy. What are the weights of HF and CC in the value-weighted market index of all stocks? What is the standard deviation of the value-weighted index return? Why would anyone hold this value-weighted index when it is riskier than the portfolio you constructed in part a)? Continuing to assume that the CAPM holds, what are the betas of HF and CC with the value-weighted market index? Explain how these betas can be nonzero even though HF and CC are uncorrelated with one another.Explanation / Answer
* std dev = SD = standard deviation
= -0.02 /( 0.1-0.06)
= - 0.02 /0.04
-0.5
So 1 - 0.50, hence the weightage is 50% of both portfolis or it's equal
((0.10) sqare - (0.1) x (0.3)) / ((0.10) square + (0.30) square) - 2 x (0.30) x (0.10)
Expected return Standard Deviation High Flyer Index 12% 30% Cash Cow index 2% 10%