You are discussing your 401(k) with Dan Ervin when he mentions that Sarah Brown, a representative...

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You are discussing your 401(k) with Dan Ervin when he mentionsthat Sarah Brown, a representative from Bledsoe Financial Services,is visiting East Coast Yachts today. You decide that you shouldmeet with Sarah, so Dan sets up an appointment for you later in theday.
When you sit down with Sarah, she discusses the variousinvestment options available in the company’s 401(k) account. Youmention to Sarah that you researched East Coast Yachts before youaccepted your new job. You are confident in management’s ability tolead the company. Analysis of the company has led to your beliefthat the company is growing and will achieve a greater market sharein the future. You also feel you should support your employer.Given these considerations, along with the fact that you are aconservative investor, you are leaning toward investing 100 percentof your 401(k) account in East Coast Yachts.
Assume the risk-free rate is the historical average risk-freerate (in Chapter 10). The correlation between the bond fund and thelarge-cap stock fund is .16. (Note: The spreadsheet graphing and“Solver” functions may assist you in answering the followingquestions.)
Considering the effects of diversification, how should Sarahrespond to the suggestion that you invest 100 percent of your401(k) account in East Coast Yachts stock?
After hearing Sarah’s response to investing your 401(k) accountentirely in East Coast Yachts stock, she has convinced you thatthis may not be the best alternative. Since you are a conservativeinvestor, you tell Sarah that a 100 percent investment in the bondfund may be the best alternative. Is it?
Using the returns for the Bledsoe Large-Cap Stock Fund and theBledsoe Bond Fund, graph the opportunity set of feasibleportfolios.
After examining the opportunity set, you notice that you caninvest in a portfolio consisting of the bond fund and the large-capstock fund that will have exactly the same standard deviation asthe bond fund. This portfolio will also have a greater expectedreturn. What are the portfolio weights and expected return of thisportfolio?
Examining the opportunity set, notice there is a portfolio thathas the lowest standard deviation. This is the minimum varianceportfolio. What are the portfolio weights, expected return, andstandard deviation of this portfolio? Why is the minimum varianceportfolio important?
A measure of risk-adjusted performance that is often used is theSharpe ratio. The Sharpe ratio is calculated as the risk premium ofan asset divided by its standard deviation. The portfolio with thehighest possible Sharpe ratio on the opportunity set is called theSharpe optimal portfolio. What are the portfolio weights, expectedreturn, and standard deviation of the Sharpe optimal portfolio? Howdoes the Sharpe ratio of this portfolio compare to the Sharpe ratioof the bond fund and the large-cap stock fund? Do you see aconnection between the Sharpe optimal portfolio and the CAPM? Whatis the connection?

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3.7 Ratings (502 Votes)

1 Considering that the company is in the growth stage andaiming to achieve higher market share though the investor believesin the company but being of conservative nature Sarah would adviseto go for diverse investing in funds See Answer

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You are discussing your 401(k) with Dan Ervin when he mentionsthat Sarah Brown, a representative from Bledsoe Financial Services,is visiting East Coast Yachts today. You decide that you shouldmeet with Sarah, so Dan sets up an appointment for you later in theday.When you sit down with Sarah, she discusses the variousinvestment options available in the company’s 401(k) account. Youmention to Sarah that you researched East Coast Yachts before youaccepted your new job. You are confident in management’s ability tolead the company. Analysis of the company has led to your beliefthat the company is growing and will achieve a greater market sharein the future. You also feel you should support your employer.Given these considerations, along with the fact that you are aconservative investor, you are leaning toward investing 100 percentof your 401(k) account in East Coast Yachts.Assume the risk-free rate is the historical average risk-freerate (in Chapter 10). The correlation between the bond fund and thelarge-cap stock fund is .16. (Note: The spreadsheet graphing and“Solver” functions may assist you in answering the followingquestions.)Considering the effects of diversification, how should Sarahrespond to the suggestion that you invest 100 percent of your401(k) account in East Coast Yachts stock?After hearing Sarah’s response to investing your 401(k) accountentirely in East Coast Yachts stock, she has convinced you thatthis may not be the best alternative. Since you are a conservativeinvestor, you tell Sarah that a 100 percent investment in the bondfund may be the best alternative. Is it?Using the returns for the Bledsoe Large-Cap Stock Fund and theBledsoe Bond Fund, graph the opportunity set of feasibleportfolios.After examining the opportunity set, you notice that you caninvest in a portfolio consisting of the bond fund and the large-capstock fund that will have exactly the same standard deviation asthe bond fund. This portfolio will also have a greater expectedreturn. What are the portfolio weights and expected return of thisportfolio?Examining the opportunity set, notice there is a portfolio thathas the lowest standard deviation. This is the minimum varianceportfolio. What are the portfolio weights, expected return, andstandard deviation of this portfolio? Why is the minimum varianceportfolio important?A measure of risk-adjusted performance that is often used is theSharpe ratio. The Sharpe ratio is calculated as the risk premium ofan asset divided by its standard deviation. The portfolio with thehighest possible Sharpe ratio on the opportunity set is called theSharpe optimal portfolio. What are the portfolio weights, expectedreturn, and standard deviation of the Sharpe optimal portfolio? Howdoes the Sharpe ratio of this portfolio compare to the Sharpe ratioof the bond fund and the large-cap stock fund? Do you see aconnection between the Sharpe optimal portfolio and the CAPM? Whatis the connection?