Assume that the capital market is in equilibrium,the risk free rate is 2%,and the return on the market is 12%.You want to construct a portfolio on the SML with an expected return of 16%.What are the portfolio weights?
A) -0.4, 1.4
B) -0.1, 1.1
C) 0.2, 0.8
D) 0.4, 0.6
E) 0.4, -1.4

Question

Quizplus · Accepted Answer

Let w be the weight of the risk-free asset: E(k_p) = w k_F + (1 - w)k_M 0.16 = 0.02w + (1 - w)0.12 0.16 = 0.02w + 0.12 - 0.12w 0.04 = 0.02w - 0.12w 0.04 = -0.10w w = -0.4 The weight of the market = 1 - w: 1 - (-0.4) = 1.4 A negative weight on the risk free asset and a weight greater than one on the market portfolio imply buying the market on margin, or borrowing at the risk free rate to buy more of the market portfolio.

Assume That the Capital Market Is in Equilibrium,the Risk Free