!!"# ! - !"#$%&"' ) *+,*-%*.

/'01*20

noLe: llgures of lnLermedlaLe resulLs ln Lhls soluLlon may be rounded for slmpllclLy of noLaLlon only. llnal resulLs are Lhe only ones Lo
be rounded accordlng Lo Lhe rules of Lhe game.
art 1:
uest|on 1:
1he correcL answers ln 1able1:
!"#$% '!"#$%&'() +,-.,/01 +,2314 ,-1 5-141/617 ,4 8326.5214 9: ;<
=>
? @1 A156 9/2B 6C9 7.D.64 ,:61- 6E1 59./6F
Stock A Stock 8
Average return () 3.24 3.47
Var|ance

22.9

64.6
Standard dev|at|on () 4.78 8.03
Annua||zed average return () 38.88 41.62
Annua||zed var|ance

274.3

774.6
Annua||zed standard dev|at|on () 16.36 27.83



Lxp|anat|ons:
8y deflnlLlon, a reLurn ls Lhe raLe of lncrease of a caplLal beLween Lhe beglnnlng and end of a speclfled perlod. 1here are Lwo
ways Lo calculaLe lL, Lhe 7.40-161 816E97 and Lhe 09/6./3934 9/1.
1he 7.40-161 -163-/ (ln case of non-dlvldend dlsLrlbuLlon) ls equal Lo Lhe flnal prlce mlnus Lhe lnlLlal prlce dlvlded by Lhe lnlLlal
prlce: ! !
!
!
!!
!
!
!
. ln case of a dlvldend, Lhls laLLer should be added ln Lhe numeraLor. 1he raLe of reLurn can be calculaLed
every day or aL dlfferenL perlods of Llme (week, monLh, year) buL a dlscreLe reLurn can also be calculaLed over Lhe whole
perlod.
1he naLural logarlLhmlc of Lhe raLlo(S
1
/S
o
) !"
!
!
!
!
, or also !!"!
!
!!"!
!
! ls used for 09/6./3934 reLurns calculaLlon. 1hls ls Lhe
convenLlon we adopLed here. uslng a conLlnuous compoundlng reLurn assumes LhaL
L
=
L-1
exp (r
L
) where r
L
ls Lhe raLe of
reLurn durlng Lhe perlod (L-1, L), and
L
Lhe prlce of Lhe asseL aL perlod L. Suppose LhaL r
1
, r
2
,.r
12
are Lhe reLurns for 12
perlods , Lhen Lhe prlce of Lhe sLock aL Lhe end of Lhe 12 perlods wlll be:

12
=
0
exp (r
1
+r
2
..r
12
)
We prove LhaL Lhe conLlnuous reLurn for Lhe whole year ls Lhe arlLhmeLlc sum of Lhe conLlnuous reLurns calculaLed on Lhe
Lwelve monLhs:
!"
!
!
!
!
! !"
!
!
!
!!!
!!"
!
!!!
!
!!!
!!!"
!
!
!
!
!!"
!
!
!
!
! !
!
!!
!!!
!!!
!
!!
!


Average and mean wlll be used lndlfferenLly ln Lhe followlng. So, Lhe ,+1-,D1 reLurn L(x) or, by deflnlLlon also, lLs 81,/ +,231
denoLed ofLen !, ls maLhemaLlcally Lhe expecLed value of Lhe varlable x. 1he average reLurn ls calculaLed uslng Lhe Lxcel
worksheeL funcLlon AvL8ACL.
1o measure rlsk, flnance ofLen relles on sLandard devlaLlon, noLed o. ln porLfollo Lheory, Lhe rlsk corresponds Lo Lhe sLandard
error of Lhe sLock's reLurn, and noL Lhe sLock's prlce. 1he sLandard devlaLlon ls Lhe square rooL of Lhe varlance. 1he varlance
ls compuLed uslng Lhe Lxcel worksheeL funcLlon vA8. whlch ls used Lo calculaLe Lhe populaLlon varlance (whereas vA8 ls


used ln sample calculaLlon), we used Lhe populaLlon varlance and covarlance because Lhe daLa do noL represenL a small
sample, lL may be consldered Lo be an enLlre populaLlon. lLs maLhemaLlcal formula ls:
!"# ! !
!
!
!!
! !
!!!
!
! ! !
!
! !!!!!.
SLaLlsLlcally Lhe sLandard devlaLlon measures Lhe average dlsperslon Lo mean (or cenLral value). SLandard devlaLlon has Lhe
greaL advanLage when compared Lo varlance Lo be expressed ln Lhe same unlL as Lhe one ln whlch Lhe daLa are measured.
MaLhemaLlcally, for daLa x, we have Lhus:
! ! ! !
!
! ! !
!

We used Lhe Lxcel worksheeL funcLlon S1Luv or equally SC81 (vA8).

uest|on 2:
1he correcL answers are ln 1able 2:
!"#$%&'() +,-.,/01 +,2314 ,-1 5-141/617 ,4 8326.5214 9: ;<
=>
? @1 A156 9/2B 6C9 7.D.64 ,:61- 6E1 59./6F
%,G21 H
Covar|ance (A,8)

19.1
Corre|at|on (A,8)

49.38

Lxp|anat|ons:
1he covarlance measures Lhe degree Lo whlch varlables change LogeLher. When varlables Lend Lo move on Lhe same
dlrecLlon Lhe varlance ls poslLlve. When lL ls negaLlve, Lhe varlables move ln opposlLe dlrecLlon. lf we Lake Lwo varlables ? and
? we have Lhe maLhemaLlcal formula:


!"# !! ! ! ! ! !! ! ! !! !
8y deflnlLlon, Lhe covarlance of a varlable wlLh lLself ls equal Lo lLs varlance. 1o calculaLe Lhe covarlance beLween Lhe Lwo
sLock reLurns, we consLrucLed Lhe Lwo columns of Lhe dlfferences beLween Lhe reLurns and Lhelr means, we calculaLed Lhelr
producLs and Lhen Lhe average (or mean) of Lhe producLs. We can also use Lhe Lhe Lxcel worksheeL funcLlon CCvA8 beLween
Lhose Lwo columns. 1he correlaLlon coefflclenL measures Lhe normallzed covarlance, l.e. Lhe covarlance dlvlded by Lhe
producL of Lhe sLandard errors :
!"##$%&'(") !"#$$%!%#&' !! ! !
!"#!!! !!
!
!
! !
!

Always comprlsed beLween -1 and 1, Lhe correlaLlon coefflclenL measures Lhe degree of llnear co-movemenLs beLween Lwo
varlables. AnoLher way Lo look aL Lhe correlaLlon coefflclenL beLween Lwo sLocks A and 8 ls Lo regress Lhe reLurns of sLock 8
on Lhose of sLock A and use Lhe Lxcel worksheeL funcLlon 18Lnu: Lhe correlaLlon coefflclenL ls Lhe square rooL of Lhe
regresslon 8 " glven by Lhe sofLware.

uest|on 3:
1he correcL answers are ln 1able 3.
%,G21 I !"#$%&'() +,-.,/01 +,2314 ,-1 5-141/617 ,4 8326.5214 9: ;<
=>
? @1 A156 9/2B 6C9 7.D.64 ,:61- 6E1 59./6J 46,/7,-7 71+.,6.9/ .4
1K5-14417 ./ LFF
ortfo||o 1
Average return 3.33
Var|ance

31.4
Standard dev. 3.60



Lxp|anat|ons:
1he mean or average reLurn of a porLfollo ls slmply Lhe welghLed sum of Lhe asseLs composlng Lhe porLfollo. So lf Lhe
proporLlon of A and 8 are respecLlvely 30, Lhe average reLurn of Lhe porLfollo wlll be 0.3*L(x
A
) +0.3* L(x
8
) wlLh L(x
A
), L(x
8
)
Lhe expecLed reLurns of Lhe asseL A and 8 respecLlvely. As for Lhe rlsk !, lf Lhe reference proporLlon for asseL A ls denoLed
a , Lhe varlance (l.e. Lhe square of ! ) of Lhe porLfollo ls glven by Lhe equaLlon:
!
!
! ! !
!
!
!
! ! ! !!
!
!
!
! !!! ! !! !"# !! !
Cr equally, uslng now Lhe correlaLlon coefflclenL beLween A and 8:
!
!
! ! !!!!!!! ! ! !!
!
!
!
!!! !!! ! !! !"!!!!!!!
1o compuLe lL, we bullL Lhe column of Lhe welghLed sum of Lhe average reLurns and Lhen we applled Lhe Lxcel worksheeL
funcLlon vA8 Lo lL.



uest|on 4:
1he correcL answers are ln 1able 4.
%,G21 > !"#$%&'() +,-.,/01 +,2314 ,-1 5-141/617 ,4 8326.5214 9: ;<
=>
? @1 A156 9/2B 6C9 7.D.64 ,:61- 6E1 59./6J 46,/7,-7 71+.,6.9/ .4 1K5-14417
./ LF
We|ght of stock A |n the portfo||o Av. return Standard dev.
0.0 3.47 8.034
7.3 3.4S 7.616
13.0 3.43 7.212
22.3 3.42 6.82S
30.0 3.40 6.4S7
37.3 3.38 6.113
43.0 3.37 S.796
32.3 3.3S S.S11
60.0 3.33 S.264
67.3 3.31 S.060
73.0 3.30 4.904
82.3 3.28 4.801
90.0 3.26 4.7SS
97.3 3.2S 4.766
103.0 3.23 4.836
112.3 3.21 4.960
120.0 3.19 S.136
127.3 3.18 S.3S8
133.0 3.16 S.621
142.3 3.14 S.919
130.0 3.13 6.247


Lxp|anat|ons:
uslng prevlous formulas for reLurns and rlsks and Lhe proporLlon lnvesLed ln asseL A as lnpuL parameLer, we bulld Lhe 1able 4
for Lhe porLfollo performance sLaLlsLlcs, assumlng LhaL borrowlng and shorL selllng an asseL are posslble. lL calculaLes Lhe rlsk
reLurn performance as a funcLlon of Lhe proporLlon of sLock A ln Lhe porLfollo. So, Lhe proporLlon of A can be hlgher Lhan
100.
uest|on S:
1he correcL answers are ln 1able 3.
!"#$%&'() +,-.,/01 +,2314 ,-1 5-141/617 ,4 8326.5214 9: ;<
=>
? @1 A156 9/2B 6C9 7.D.64 ,:61- 6E1 59./6J 46,/7,-7 71+.,6.9/ .4 1K5-14417 ./ LF
%,G21 M
We|ght of each stock |n C D L I
ortfo||o 2 20 30 40 10
ortfo||o 3 20 10 10 60

ortfo||o 2
keturn 9.10
Var|ance 1.216
ortfo||o 3
keturn 12.00
Var|ance .02
Covar|ance between 2 and 3 .07

Lxp|anat|ons:
1he reLurn of a porLfollo 8 ls compuLed as follows: !
!
! !
!
!, where M represenLs Lhe column-vecLor of reLurn for Lhe llsLed
sLocks (so lLs Lranspose M' ls a row-vecLor), and x ls Lhe column-vecLor of Lhe compuLed proporLlons. ln Lxcel, Lhls


compuLaLlon ls easlly done wlLh Lhe funcLlon SuM8CuuC1. 1he lndlvldual elemenLs of Lhe vecLors need Lo be ln Lhe same
order for Lhe answer Lo be correcL.
1he varlance of a porLfollo ls: !"#!!
!
! ! !
!
!", where x represenLs Lhe column vecLor of sLock proporLlons and S ls Lhe
varlance-covarlance maLrlx. S ls a 4x4 maLrlx and x ls a column-vecLor conLalnlng 4 elemenLs, so Lhe resulL ls a scalar:
!!
!!!
!
!!!
!
!!!
! !"#!!
!
! . ln Lxcel, Lhls compuLaLlon can more easlly be execuLed wlLh nesLed MMuL1 funcLlons.

1he 1able 3 ls a generallzaLlon of a prevlous one (1able 3). 1he porLfollos 2 and 3 have been randomly" consLrucLed now
wlLh four asseLs C, u, L, l. 1he Lwo varlances and Lhe covarlance beLween Lhe porLfollos 2 and 3 have been calculaLed wlLh
Lhe funcLlons vA8. and CCvA8.
1he maLhemaLlcs of Lhls generallzaLlon ls followlng, Lhe maLrlx noLaLlon slmpllfylng Lhe wrlLlng of Lhe porLfollo problem. lf
Lhe proporLlon of asseL . ln Lhe porLfollo ls denoLed by Y lL ls convenlenL Lo wrlLe Lhe porLfollo proporLlons as a column vecLor:

!
!
!
!
"
#
$
$
$
$
%
&
= '
N
(
(
.
.
1

We wrlLe Lhe Lransposed vecLor of l as :
[ ]
N
T
! ! . .
1
= "
1he expecLed reLurn of Lhe porLfollo whose proporLlons are glven by l ls Lhe welghLed average of Lhe expecLed reLurns of Lhe
lndlvldual asseLs.
!
=
N
i i p
r E r E ) ( ) ( "


We wrlLe L(r) and L(r)
1
Lhe column and row (respecLlvely) vecLor of asseL reLurns. We wrlLe Lhe expecLed porLfollo reLurn ln
maLrlx noLaLlon as:
! = ! = =
"
T T
N
i i p
r E r E r E r E ) ( ) ( ) ( ) ( #
1he varlance of Lhe porLfollo ls glven by:
!! ! !! !
= + = = + =
+ = + =
N
i
N
i j
ij j i
N
ii i
N
i
N
i j
j i j i
N
i i p
r r Cov r Var r Var
1 1 1 1
2 ! ) , ( 2 ) ( ! ) ( " # # " # # # #
We may Lhen wrlLe:
!!
=
ij j i p
r Var " # # ) (
1he mosL pracLlcal represenLaLlon of Lhe porLfollo varlance (especlally when Lhe markeL ls large) uses maLrlx noLaLlon. We
call Lhe maLrlx LhaL has !
!"
ln Lhe ."Lh row and Lhe N"Lh column Lhe varlance- covarlance maLrlx:
!
!
!
!
"
#
$
$
$
$
%
&
=
NN N
N
S
' '
' '
' ' '
... ...
... ... ... ...
... ...
...
1
22 21
1 12 11

1he porLfollo varlance ls glven by :
! ! = S r Var
T
p
) (
lf now we denoLe [ ]
N
! ! . .
1 1
= " Lhe proporLlons of porLfollo 1 and [ ]
N
! ! . .
1 2
= " Lhe proporLlons of porLfollo 2 we
can evaluaLe LhaL Lhe covarlance of Lhe Lwo porLfollos ls:


T
p
S r Cov Cov
2 1
) ( ) 2 , 1 ( ! ! = =

uest|on 6:

1he correcL answers are ln 1able 6.
! "#$%&'() +,-.,/01 +,2314 ,-1 5-141/617 ,4 8326.5214 9: ;<
=>
? @1 A156 9/2B 6C9 7.D.64 ,:61- 6E1 59./6J 46,/7,-7 71+.,6.9/ .4 1K5-14417 ./ LF
%,G21 O
We|ght of 2 |n the portfo||o Av. keturn Standard dev.
-80.0 14.32 72.88
-63.0 13.89 67.22
-30.0 13.43 61.72
-33.0 13.02 36.40
-20.0 12.38 31.33
-3.0 12.13 46.39
10.0 11.71 42.28
23.0 11.28 38.37
40.0 10.84 33.63
33.0 10.41 33.66
70.0 9.97 32.84
83.0 9.34 33.26
100.0 9.10 34.87
113.0 8.67 37.31
130.0 8.23 41.00
143.0 7.80 43.13
160.0 7.36 49.74



Lxp|anat|ons:
1he 1able 6 ls also slmllar Lo 1able 4. lL ls consLrucLed assumlng LhaL a porLfollo ls made ouL of Lhe Lwo porLfollos 2 and 3
descrlbed ln Lhe 1able 3. We agaln admlLLed LhaL borrowlng and shorL selllng were posslble so Lhe proporLlons lnvesLed ln
one porLfollo can be hlgher Lhan 100. We have now Lo LesL lf a llnear comblnaLlon of porLfollos 2 and 3 can glve an
efflclenL fronLler.
ln llLerary Lerms, Lhe deflnlLlon of Lhe efflclenL fronLler ls a seL of opLlmal porLfollos LhaL offers Lhe hlghesL expecLed reLurn
for a deflned level of rlsk or, conversely, Lhe lowesL rlsk for a glven level of expecLed reLurn. orLfollos LhaL lle below Lhe
efflclenL fronLler are 43G=956.8,2, because Lhey do noL provlde enough reLurn for Lhe level of rlsk. orLfollos LhaL clusLer Lo
Lhe rlghL of Lhe efflclenL fronLler are also sub-opLlmal, because Lhey have a hlgher level of rlsk for Lhe deflned raLe of reLurn.
1he efflclenL fronLler ls curved because Lhere ls a dlmlnlshlng marglnal reLurn Lo rlsk. Lach unlL of rlsk added Lo a porLfollo
galns a smaller and smaller amounL of reLurn.
MaLhemaLlcally, an efflclenL porLfollo ls Lhe porLfollo of rlsky asseLs LhaL glves Lhe lowesL varlance of reLurn of all porLfollos
havlng Lhe same expecLed reLurns. AlLernaLlvely an efflclenL porLfollo has Lhe hlghesL expecLed reLurn of all porLfollos havlng
Lhe same varlance. lor a glven reLurn 8, an efflclenL porLfollo 5 ls one LhaL solves ) (
p ij j i
r Var x x Min
!!
= " sub[ecL
Lo ) (
p i i
r E m r x
!
= = and
!
=1
i
x .
1he efflclenL fronLler ls Lhe seL of all efflclenL porLfollos. 8lack 1976 proved LhaL Lhe efflclenL fronLler ls Lhe locus of all convex
comblnaLlons of any Lwo efflclenL porLfollos. 1herefore , lf } {
N N
x x x x , ,....
1 1 !
= and } {
N N
y y y y , ,....
1 1 !
= are efflclenL porLfollos
and lf , ls a consLanL Lhen Lhe porLfollo P deflned by :



!
!
!
!
"
#
$
$
$
$
%
&
' +
' +
' +
= ' + =
N N
y a ax
y a ax
y a ax
y a ax z
) 1 (
...
) 1 (
) 1 (
) 1 (
2 2
1 1

ls also efflclenL : Lhus we can flnd Lhe whole efflclenL fronLler lf we can flnd any Lwo efflclenL porLfollos. WlLh Lhls Lheorem
once we have found Lwo efflclenL porLfollos K and B we know LhaL any oLher efflclenL porLfollo ls a convex comblnaLlon of K
and B. lf we denoLe Lhe mean and Lhe varlance of K and B by } {
2
), (
x x
r E ! and } {
2
), (
y y
r E ! and lf y a ax z ) 1 ( ! + = Lhen :
) ( ) 1 ( ) ( ) (
y x z
r E a r aE r E ! + =

!
!
!
! !
!
!
!
!
! ! !!
!
!
!
!
!!! ! !! !"# !! ! =!
!
!
!
!
! ! !!
!
!
!
!
!!! ! !! !
!
!"




uest|on 7:
1he correcL answers are ln 1able 7.
!"#$%&'() +,-.,/01 +,2314 ,-1 5-141/617 ,4 8326.5214 9: ;<
=>
? @1 A156 9/2B 6C9 7.D.64 ,:61- 6E1 59./6J 46,/7,-7 71+.,6.9/ .4 1K5-14417 ./ LF
%,G21 Q
1he porLfollos resulLlng from Lhe comblnaLlon of 2 and 3 are lylng on Lhe
efflclenL fronLler lalse
8ecause
A slngle sLock has a beLLer rlsk/reLurn proflle Lhan Lhe comblnaLlon of 2 and
3 1rue
1he rlsk-reLurn curve of Lhe comblnaLlon of 2 and 3 ls an hyperbola lalse
1he comblnaLlon of Lwo dlverslfled porLfollo always makes an efflclenL fronLler lalse

Lxp|anat|ons:
1o answer Lhe quesLlon of Lhe efflclenL fronLler LhaL ls supposed Lo be drawn from Lhe Lwo porLfollos 2 and 3 and
maLhemaLlcally descrlbed above, lL ls necessary Lo draw Lhe efflclenL fronLler obLalned when comblnlng Lhe Lwo porLfollos 2
and 3 Lo obLaln a global porLfollo.
1hls ls done by ploLLlng all Lhe polnLs of Lhls global porLfollo (rlsk, reLurns - ln blue for Lhe boLLom branch and green for Lhe
upper branch of Lhe hyperbole whlch ls preclsely Lhe fronLler) slmulaLlng Lhe proporLlons lnvesLed respecLlvely ln Lhe Lwo
lnlLlal porLfollos. 8uL lf we ploL Lhe four baslc asseLs C, u, L and l we can see LhaL one asseL u (ln red) dlsplays a hlgher reLurn
for Lhe same quanLlLy of rlsk Lhan Lhe upper llmlL (ln green). lL domlnaLes Lhe efflclenL fronLler.













0
0,02
0,04
0,06
0,08
0,1
0,12
0,14
0,16
0 0,1 0,2 0,3 0,4 0,3 0,6 0,7 0,8
SLock A
SLock 8
SLock C
SLock u
k|sk
keturn


art 2
uest|on 1:
1he correcL answers ln 1able 1:
!"#$% ( !"#$%&'() @1 A156 9/2B 6C9 7.D.64 ,:61- 6E1 59./6F

8eta
SLock C 1.48
SLock P 1.08
SLock l 1.31
SLock ! 1.30
SLock k 0.26
SLock L 0.49
unlverse ClLy SLock lndex 1.00

Lxp|anat|ons:
1he equlLy beLa, also referred Lo as Lhe levered beLa, can be esLlmaLed by Laklng a raLlo of Lhe Lhe hlsLorlcal covarlance
beLween Lhe share prlce reLurn and Lhe lndex reLurn (used as a proxy for Lhe whole markeL) and Lhe varlance of Lhe markeL
reLurn.
!
!
!
!"#!!
!
! !
!
!
!"#!!
!
!

1he beLa ls a measure of Lhe volaLlllLy, or sysLemaLlc rlsk, of a securlLy or a porLfollo ln comparlson Lo Lhe markeL as a whole.
8y deflnlLlon, Lhe markeL lLself has a beLa of 1.
8eLa can be calculaLed uslng regresslon analysls or uslng Lhe maLhemaLlcal deflnlLlon above. 8eLa ls descrlbed as Lhe
Lendency of a securlLy's reLurns Lo respond Lo swlngs ln Lhe markeL. A beLa of 1 lndlcaLes LhaL Lhe securlLy's prlce wlll move


wlLh Lhe markeL. A beLa of less Lhan 1 means LhaL Lhe securlLy wlll be less volaLlle Lhan Lhe markeL. A beLa of greaLer Lhan 1
lndlcaLes LhaL Lhe securlLy's prlce wlll be more volaLlle Lhan Lhe markeL. lor example, lf a sLock's beLa ls 1.2, lL's LheoreLlcally
20 more volaLlle Lhan Lhe markeL. 1o compuLe Lhe beLas, we used Lhe Lxcel CCvA8 funcLlon and Lhe vA8. funcLlon on Lhe
maLrlx of Lhe reLurns. 1he maLhemaLlcal raLlonale behlnd Lhe resulL ls Lhe followlng one, referred Lo as Lhe S|ng|e Index
Mode|. 1he model' s baslc assumpLlon ls LhaL Lhe reLurns of each asseL !
!
can be llnearly regressed on some markeL lndex !
!
:

!
!
! !
!
! !
!
!
!
!!
!


Clven Lhls assumpLlon we easlly prove wlLh Lhe help of prevlous equaLlons:
!!!
!
! ! !
!
! !
!
!!!
!
!
!
!"
! !
!
!
!
!
!
!

1he Slngle lndex Model leads Lo greaL slmpllflcaLlons ln Lhe calculaLlon of Lhe varlance-covarlance maLrlx. 8egresslng Lhe
reLurns of each asseL on an lndex llke Lhe unlverse ClLy SLock lndex, Lhe beLas can be calculaLed elLher wlLh funcLlon SLCL
applled on Lhe column of reLurns Lo Lhe column lndex or wlLh Lhe funcLlon CCvA8 / vA8. applled wlLh Lhe same synLax. 1he
Lable above has been calculaLed uslng boLh meLhods Lo check LhaL Lhey glve Lhe same resulLs.









uest|on 2:
1he correcL answers ln 1able 2:
!"#$% (
1rue ] Ia|se
1he porLfollo 4 ls lylng on Lhe
efflclenL fronLler 1rue
1he porLfollo 3 ls lylng on Lhe
efflclenL fronLler 1rue
1he porLfollo 6 ls lylng on Lhe
efflclenL fronLler lalse

Lxp|anat|ons:
1he raLlonale of Lhe calculaLlon ls Lo check lf porLfollos are acLually efflclenL. We begln wlLh some calculaLlons and well
known resulL due Lo l.8lack 1972. LeL 0 be a consLanL and 8-c denoLe Lhe followlng column vecLor, whlch ls Lhe column of
excesses of expecLed reLurns relaLed Lo 0.
!
!
!
!
"
#
$
$
$
$
%
&
'
'
'
= '
N N
c r E
c r E
c r E
c R
) (
...
) (
) (
2
1

S belng Lhe varlance-covarlance maLrlx, leL Lhe vecLor P solve Lhe sysLem
Sz c R = !
1hen Lhls soluLlon produces a porLfollo K on Lhe envelope of Lhe seL of porLfollo means and sLandard devlaLlons generaLed by
any porLfollo whose proporLlons sum Lo 1 (called :1,4.G21 porLfollos) ln Lhe followlng way:


{ } c R S z ! =
!1

and } {
N N
x x x x , ,....
1 1 !
= wlLh
!
=
j
j
i
i
z
z
x
All envelope porLfollos and ln parLlcular all efflclenL porLfollos are of Lhls form and are Lhe resulL of Lhe procedure descrlbed
above: lf K ls any envelope porLfollo Lhen Lhere exlsLs a consLanL 0" and a vecLor P" such as Sz c R = ! and
!
=
j
j
i
i
z
z
x . Any
Lwo envelope porLfollos } {
N N
x x x x , ,....
1 1 !
= and } {
N N
y y y y , ,....
1 1 !
= are enough Lo esLabllsh Lhe whole envelope whlch ls
slmply a convex comblnaLlon of K and B.
1hls means LhaL glven any consLanL ,, Lhe porLfollo
!
!
!
!
"
#
$
$
$
$
%
&
' +
' +
' +
= ' +
N N
y a ax
y a ax
y a ax
y a ax
) 1 (
...
) 1 (
) 1 (
) 1 (
2 2
1 1
ls on Lhe envelope of Lhe efflclenL
fronLler. lf B ls any envelope porLfollo Lhen for any porLfollo K, we have Lhe relaLlonshlp:

!!!
!
! ! ! ! !
!
! !
!
!!
where !
!
!
!"#!!!!!
!
!
!

8esldes, 0 ls Lhe expecLed reLurn of a porLfollo P whose covarlance wlLh B ls 0: ! ! !!!
!
! and !"# !! ! ! !. lf B ls on Lhe
envelope, Lhe regresslon of any and all porLfollos K on B glves a llnear relaLlonshlp. lf Lhe markeL porLfollo R ls efflclenL (a
heavy assumpLlon we wlll LesL hereafLer) Lhe prevlous resulL ls also Lrue for Lhe markeL porLfollo. 1haL ls Lhe Secur|ty Market
L|ne wlLh !!!
!
! subsLlLuLe for 0:
!!!
!
! ! !!!
!
! ! !
!
!! !
!
!!!!
!
!!


Where !
!
!
!"#!!!!!
!
!
!

And !"# !! ! ! !
noLe LhaL here, Lhe role of Lhe rlsk free asseL ls played by a porLfollo wlLh a zero beLa wlLh respecL Lo Lhe parLlcular envelope
porLfollo B. When Lhere ls a rlsk free asseL, Lhe resulL above speclallzes Lo Lhe securlLy markeL llne of Lhe classlcal Cap|ta|
Asset r|c|ng Mode| :
! !
!
! !
!
! !
!
! !
!
!!
!

lf all lnvesLors choose Lhelr porLfollos only on Lhe basls of porLfollo mean and sLandard devlaLlon, Lhen M ls a porLfollo
composed of all rlsky asseLs ln Lhe economy, each asseL Laken ln proporLlon of lLs value. 1he only real LesL of Lhe CAM ls
wheLher Lhe Lrue markeL porLfollo ls mean varlance efflclenL. lf M ls an efflclenL porLfollo soluLlon of Sz r R
f
= ! and
!
=
=
1 j
j
i
i
z
z
M , all (convex) comblnaLlons of porLfollo M and Lhe rlsk-free asseL wlll be called Lhe Cap|ta| Market ||ne. A
porLfollo locaLed on LhaL llne wlll dlsplay Lhe followlng rlsk/reLurn relaLlon:

! !
!
! !"
!
!!! !!!! !
!

!
!
! !! !!!!
!

M" ls referred Lo as Lhe MarkeL porLfollo, Lhe only porLfollo of rlsky asseLs lncluded ln any opLlmal porLfollo. lL lncludes all
Lhe rlsky asseLs wlLh each asseL welghLed ln proporLlon Lo lLs markeL value. 1o flnd M when !
!
ls known, lmplles slmply Lo
solve Lhe above sysLem glven LhaL Lhe consLanL ! ! !
!
. When Lhe rlsk- free raLe changes, we geL a dlfferenL markeL porLfollo.
So we creaLe flrsL Lwo efflclenL porLfollos by lmplemenLlng Lhe procedure [usL descrlbed above (deLermlnaLlon of Lwo
porLfollos generaLlng Lhe convex fronLler whlch ls ploLLed LhereafLer). A convex comblnaLlon of Lhose Lwo porLfollos, named
4 and 3, wlll generaLe Lhe whole efflclenL fronLler. 1he fronLler ls ploLLed. 1he porLfollo 6 ls clearly lnefflclenL slnce lL ls
ouLslde Lhe upper parL of Lhe hyperbole.


uest|on 3:
1he correcL answers ln 1able3:
!"#$% )
C P l ! k L
C 0.20393
P 0.03732 0.07904
l 0.10773 0.03348 0.08674
! 0.04926 0.10284 0.04429 0.44333
k 0.02083 0.00891 0.01944 0.01923 0.00831
L 0.00386 0.04038 0.01484 0.02736 -0.00148 0.03921

Lxp|anat|ons:
1he clearesL and qulckesL meLhod for calculaLlng Lhe varlance covarlance maLrlx as lL appears above ls an on- screen meLhod
whlch uses Lhe excess reLurn maLrlx. Suppose LhaL we have ( rlsky asseLs and LhaL for each asseL we have reLurn daLa for M
perlods. 1hen Lhe excess reLurn maLrlx # wlll look llke:
!
!
!
!
"
#
$
$
$
$
%
&
' '
'
' '
= =
r r r r
r r
r r r r
returns excess of matrix A
NM M
N
... ...
... . . ...
... . .
... ...
1
12
1 11

1he Lranspose of Lhe maLrlx ls:
!
"
#
$
%
&
' '
' '
=
r r r r
r r r r
A
NM N
M T
... ...
... ...
1
1 11

MulLlplylng
T
A Llmes A and dlvldlng Lhrough by Lhe number of perlods M glves Lhe varlance -covarlance maLrlx S:


! ! !
!"
!
!
!
! !
!

1haL ls whaL has been done here. We flrsL calculaLed Lhe mean reLurn for each asseL , by uslng Lhe already menLloned Lxcel
funcLlon AvL8ACL on each column of Lhe daLa, Lhen subLracLlng each asseL's mean reLurn from each of Lhe perlodlc reLurn
glves Lhe excess reLurn maLrlx. uslng Lhe array funcLlon 18AnSCSL glves Lhe Lransposed maLrlx 1o enLer Lhe formula
18AnSCSL, mark Lhe area of Lhe maLrlx, Lype 18AnSCSL on Lhls area and flnlsh wlLh [CLrl] +[ShlfL] +[LnLer]. 1o calculaLe
Lhe varlance-covarlance maLrlx lL ls necessary Lo mulLlply
T
A Llmes A . We used agaln Lhe array funcLlon
MMuL1(A_18AnSCSL, A)/n. ln Lhe same way, Lype 18AnSCSL on Lhe concerned area and flnlsh wlLh [CLrl] +[ShlfL] +[LnLer].

uest|on 4:
1he correcL answers ln 1able 4:
!"#$% *
We|ght
orLfollo 4 () -1.43
orLfollo 3 () 2.43
keturn
8eLurn of Lhe porLfollo 7 () 22.78

Lxp|anat|ons:
1he efflclenL fronLler meLhod and Lhe slmulaLlons consLrucLed aL Lhe prevlous sLep help us Lo consLrucL a porLfollo whose rlsk
equals Lhe markeL rlsk. lndeed we have Lo flnd Lhe respecLlve proporLlons of porLfollo 4 and porLfollo 3 Lo bulld a porLfollo 7
whlch wlll dlsplay a rlsk of 0.1896 whlch ls preclsely Lhe global markeL rlsk. We can use an Lxcel CCAL SLLk Lo manlpulaLe a
speclflc cell so LhaL one of Lhe porLfollos slgma wlll be equal Lo Lhe sLandard devlaLlon of Lhe unlverse ClLy SLock lndex. 1hls
speclflc cell wlll show Lhe dlfference beLween Lhe varlous porLfollos proporLlons. lL ls also posslble Lo flnd lL numerlcally by


decreaslng llLLle by llLLle Lhe lnlLlal proporLlon of 4. We Look -2.00 (l.e. -200) as an lnlLlal value for LhaL proporLlon. 1he
Lable shows LhaL, for a rlsk (s)of 0.1896, Lhe expecLed reLurn of 7 ls 22.78.
uest|on S:
1he correcL answers ln 1able 3:
!"#$% +
Sharpe raLlo
orLfollo 4 1.34
orLfollo 3 1.23
orLfollo 6 0.09
orLfollo 7 0.93

Lxp|anat|ons:
1he Sharpe raLlo ls a measure of sLock or fund performance, lL measures Lhe reward per unlL of rlsk. 8y deflnlLlon, lL ls Lhe
raLlo of an asseL's excess reLurn Lo lLs volaLlllLy. lL ls also known as Lhe reward-Lo-varlablllLy raLlo. 1he Sharpe raLlo can be
compuLed elLher as an ex-anLe or ex-posL. MaLhemaLlcally, Lhe Sharpe raLlo, ln lLs ex-posL expresslon (based on reallzed
reLurns) ls as follows:

!!!"#$ !"#$% !
!!!
!
!!!
!
!
!


where T!-
U
)ls Lhe reLurn on an asseL or porLfollo U, -
:
ls Lhe reLurn on Lhe benchmark asseL, and V
U
ls Lhe sLandard devlaLlon
of -
U
.

We Lake Lhe efflclenL porLfollos 4 and 3 as reference muLual funds' porLfollos. 1he rlsk free raLe ls 3. We selecL Lhe
porLfollos accordlng Lo Lhelr performance. CLher measures of performance are avallable, Lhe mosL used belng:



1reynor raLlo
1he 1reynor raLlo ls a measure of sLock performance. lL measures Lhe performance of an asseL . compared Lo a rlsk free asseL
(Lyplcally 1reasury bllls) per unlL of assumed markeL rlsk. MaLhemaLlcally, Lhe 1reynor raLlo ls as follows:
!" !
!!!
!
! !!
!
!
!

Where -
.
ls Lhe reLurn on asseL & !9- , 59-6:92.9F, -
:
ls Lhe reLurn on Lhe rlsk free asseL, and W
.
ls Lhe beLa of asseL (resp.Lhe
porLfollo) ..
1he 1reynor raLlo can also be compuLed for a porLfollo, Lhe hlgher ls Lhe 1reynor raLlo, Lhe beLLer ls Lhe performance of Lhe
fund. 1reynor raLlos are commonly used Lo rank fund managers. 1he ranklng glven by 1reynor raLlos ls usually Lhe same as
Lhe ranklng obLalned vla !ensen's alpha because boLh of Lhem rely on sysLemaLlc rlsk. 1heoreLlcally, Lhe 1reynor raLlo can be
negaLlve, buL ln Lhls case lL ls very dlfflculL Lo lnLerpreL. A negaLlve 1reynor raLlo may lmply LhaL Lhe fund manager has
ouLperformed Lhe rlsk free raLe whlle reduclng sysLemaLlc rlsk (negaLlve 8eLa) whlch ls a favorable slLuaLlon. 1he opposlLe
slLuaLlon wlLh a poslLlve beLa buL havlng underperformed Lhe rlsk free reLurn ls very unfavorable.
!ensen's alpha
!ensen's alpha ls a measure of a securlLy's excess reLurn wlLh respecL Lo Lhe expecLed reLurn glven by Lhe CaplLal AsseL
rlclng Model. lnvesLors are looklng for asseLs or porLfollos wlLh poslLlves alphas, as lL slgnals poslLlve abnormal reLurn. An
asseL wlLh a poslLlve alpha has a hlgher reLurn Lhan Lhe rlsk ad[usLed reLurn esLlmaLed by Lhe CAM. CompuLaLlons of
!ensen's alpha are based on reallzed reLurns. lor a sLock or porLfollo ., we Lhus have:
!
!
! !
!
! !
!
!!
!
!
!
!!
!

where -
.
ls Lhe reLurn on asseL ., -
:
ls Lhe reLurn on Lhe rlsk free asseL, G
.
ls Lhe beLa of asseL .X and -
R
.4 Lhe markeL reLurn.




uest|on 6:
1he correcL answers ln 1able 6:
!"#$% ,
orLfollo
Clven your prevlous answers,
whlch porLfollo ls Lhe nearesL of
Lhe super-efflclenL porLfollo? [4/3/6/7]

Lxp|anat|ons:
Accordlng Lo Lhe classlcal crlLerla, 4 ls Lhe nearesL of Lhe super -efflclenL porLfollo slnce, belng efflclenL, lL also dlsplays Lhe
hlghesL performances measures.