Tom\'s portfolio consists solely of an investment in Merck stock. Merck has an e
ID: 2775637 • Letter: T
Question
Tom's portfolio consists solely of an investment in Merck stock. Merck has an expected return of 13% and a volatility of 25%. The market portfolio has an expected return of 12% and a volatility of 18%. The risk-free rate is 4%. Assume that the CAPM assumptions hold in the market.
Assuming that Tom wants to maintain the current expected return on his portfolio, then the amount that Tom should invest in the market portfolio to minimize his volatility is closest to:
A: 125%
B: 100%
C: 88.8%
D: 112.5%
Explanation / Answer
let say tom is investing $100 in merck stock @13% hence his income would be $13.
In order to get an Income of $13 at a lower rate of return than 13% he would have to invest more than $100, we can rule out options B and C.
In case he is investing 125% that is $ 125 at 12% his income would be $ 15. If he is investing $ 112.5 his income would be 13.5 which is closet to his earlier income of $13. Hence the correct option is D