Security

A
B
C
D
E
F
G
H

Expected Return
22
20
14
18
16
12
19
17

m2=
Rf=

12

Beta
1
2.5
1.5
1
0.8
1.2
1.6
2

Residual Variance
35
30
25
80
20
10
25
30

Portfolio construction under Sharpes approach:

1. Calculate the ratio of Risk Premium/Beta for each security
Security

A
B
C
D
E
F
G
H

Risk Premium
(Expected return Risk
Free return)
15
13
7
11
9
5
12
10

Beta

Risk Premium/Beta

1
2.5
1.5
1
0.8
1.2
1.6
2

15
5.2
4.666666667
11
11.25
4.166666667
7.5
5

Ranking the ratios calculated under (i) in descending orde

Security

A
E
D
G
B
H
C
F

Risk Premium/Beta

Beta2 / Residual Variance

15
11.25
11
7.5
5.2
5
4.666666667
4.166666667

Zi=[ Beta/residual variance] X [(Risk premium/Beta) - C*]

ZA

0.241549983

ZE

0.058803117

ZD

0.178169976

ZG

0.061071961
0.539595036
Wi=Zi /(Zi + Zii + Ziii + .. +Zn)

0.028571429
0.032
0.0125
0.1024
0.208333333
0.133333333
0.09
0.144

(Risk premium x Beta) / (Residual

variance)
0.428571429
0.36
0.1375
0.768
1.083333333
0.666666667
0.42
0.6

WA

45%

WE

11%

WD

33%

WG

11%
100%

Cum. Value of (Risk

Cum. Value of (Beta2 /
premium x Beta)/
Residual Variance)
(Residual variance)
0.028571429
0.428571429
0.060571429
0.788571429
0.073071429
0.926071429
0.175471429
1.694071429
0.383804762
2.777404762
0.517138095
3.444071429
0.607138095
3.864071429
0.751138095
4.464071429

C= Market variance x (Risk premium x Beta)/(Residual variance)

1 + Market variance (Beta2 / Residual variance)
3.829787234
5.479814692
5.920992541
6.545750612 C*
5.945575388
5.735612495
5.596279974
5.349579717