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December 15th, 2014, 11:12 AM   #1
Joined: Aug 2014
From: England

Posts: 14
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Math Focus: Calculus
Anybody good with finance? (Sorry if in wrong section...)

Hi, please forgive me if I am posting this in wrong section, but I really need help with something. I have this question from one of my classes but I don't get it...

The Beresfords are a retired couple who have all their capital of £200,000 invested directly in a well-diversified portfolio with very similar characteristics to the market portfolio. They have carried out some investigations and believe that they have found a security (code name N) which is perfectly negatively correlated with the market portfolio.

The Beresfords have been told by an investment analyst that since the security has a negative beta factor it is a particularly desirable security. As a result they are thinking of switching all their capital into security N.

The following information is available:

Expected return
Market portfolio (M) - 19%
Security N - 7%

Standard deviation
Market portfolio (M) - 20%
Security N - 5%

The capital market is in equilibrium.


(a) (i) Calculate the beta factor of N. Comment on the statement made by the investment analyst and on the proposed action the Beresfords are thinking of taking.

(ii) Calculate the amount of funds which the Beresfords would need to transfer from their diversified portfolio into N if they wished to achieve a risk-free return.

(iii) Calculate the return on the risk-free security.

(iv) Carefully explain under what conditions the Beresfords would be advised to switch all their capital into the risk-free security. You may assume that the Beresfords have straight line indifference curves
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