FIN 406 Lecture Notes - Lecture 23: Bkw Fmb Energie, Tangent, Sharpe Ratio

Let’s assume you live in a world where there are only 2 risky assets, asset C and asset D. There is also a risk free asset. You have the following information about the assets:

Asset C Asset D Risk free (F)

Expected Return 7% 18% 5%

Standard Deviation 17% 27% 0%

a. If you do NOT have the option to make a portfolio, which asset you pick? Explain why in two lines max.

i. Asset C

ii. Asset D

iii. Asset F

iv. It depends

b. You try all different combinations of assets C and D and you realize that P2 (50% in C and 50% in D) gives you the highest Sharp ratio. You call P2 the optimal risky portfolio or the tangency portfolio. You have a client who seeks your advice on how to invest her money to have 9.5% expected return. What combinations of assets/portfolios would you recommend her to invest in?