Construct the optimal active a

Construct the optimal active and overall risky portfolio with the data of problem 6 with no restrictions on short sales.

a. What is the Sharpe measure of the optimal risky portfolio and what is the contribution of the active portfolio?

b. Analyze the utility value of the optimal risky portfolio for the A = 2.8 investor. Compare to that of problem 6.

Problem 6

A portfolio management house approximates the return-generating process by a twofactor model and uses two factor portfolios to construct its passive portfolio. The input table that is constructed by the house analysts looks as follows:

The correlation coefficient between the two factor portfolios is .6.

a. What is the optimal passive portfolio?

b. By how much is the optimal passive portfolio superior to the single-factor passive portfolio, M, in terms of Sharpe’s measure?

c. Analyze the utility improvement to the A = 2.8 investor relative to holding portfolio M as the sole risky asset that arises from the expanded macro model of the portfolio manager.

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