For all parts of this question, assume the following: The CAPM holds. The riskless rate of return is 5%. The market portfolio has expected rate of return of 15% and standard deviation of 20%. 1. Burger Inc. stock has an expected rate of return of 4% per year and standard deviation of 30%. Linda Belcher says, "No rational person would hold a risky asset expected to return less than the riskless rate! It must be mispriced." Is Linda correct? Explain. 2. Consider the following data on two stocks whose returns have a correlation of 0.2 with each other: Expected Return Standard Deviation Walmart 5% 12% Tesla 20% 35% Bob Belcher owns $25,000 worth of Walmart stock, $10,000 worth of Tesla stock, and no other investments. a) Compute expected rate of return (% per year), and standard deviation of Bob’s portfolio. b) Mr. Belcher says he cannot tolerate any more standard deviation than her portfolio has now. Given this risk tolerance, is he maximizing her expected return? If he is, explain why? If he is not, explain how she should invest to maximize expected return (give a specific trading and investment strategy).

Explanation:

If a risk free asset is giving a return of 5%, then no one would go for an asset with 30% standard deviation (risky asset) to get 4% return. Hence, Linda is right.

2. Out of 35000 of available funds, 25000 (71.43%) are invested in Walmart and 28.57% are invested in tesla.

Expected return = W1*R1 +W2*R2 where W1 and W2 are the weights and R1 and R2 are the expected returns from each stocks.

hence, the expected return of the portfolio = 0.7143*5% + 0.2857*20%= 9.2858%

portfolio variance = (W1S1)^2 + (W2S2)^2 + 2*W1W2S1S2Cor, where S1 and S2 are standard deviation of portfolio and Cor is the correlation between these stocks

standard deviation of portfolio =( (0.7128*0.12)^2 + (0.2857*0.35)^2 + 2*0.7128*0.2857*0.12*0.35*0.2)^0.5 = 14.4%

12% >= W1'*5% + W2'*20%

W1'= 1- W2'

12% = 5% - 5%*W2' +W2'*20%

W2 = 0.466 = 16333

Hence, he should invest 16333 in Tesla and remaining in Walmart

kindly check the attached image below for the graphical presentation of the explanation to the question

cognitive overload: having a lot on your mind impairs decision-making and tends to result in the simplest, but not necessarily best, option being selected.

empathy gaps: overlooking how you might feel in a different situation can result in unnecessary purchases, such as overbuying when shopping for food on an empty stomach.

optimism and overconfidence: wearing rose-tinted glasses and having unrealistic expectations about the future can affect money management and leave you unprepared for a change in circumstance.

instant gratification: seeking instant gratification drives impulsive spending and can undermine long-term planning and savings.

harmful habits: automatic or mindless behaviour can amplify a poor financial decision as it becomes a recurring event.

social norms: we are heavily influenced by the actions of others; while this can be in certain circumstances, it also contributes to the pressure to keep up with the joneses through conspicuous consumption.

what are the options

explanation: