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6. (30 points) Let the information on your portfolio be given as follows. You have three funds in the basket. The “beta’s” among them that are estimated by using S&P 500 index are given as follows; = 1.22, = 1.03 = 0.85. Answer the following questions;
a) Why do we need these “beta’s” to construct the portfolio?
b) If the risk-free rate is given as 2%, what are the required returns for fund 1 and fund 2 if the market rate of return is expected to have 12%?
c) Is it possible to construct a risk-free (or zero-beta) portfolio by combining asset 1 and asset 2? If yes, what is the required return for this portfolio? If the transaction cost for this portfolio requires 0.5% of commission, will you do it?
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