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Answer: Asset JKL
## Explanation **Step 1: Calculate Market Risk Premium** - Risk-free rate = 3% - Market return = 8% - Market risk premium = 8% - 3% = 5% **Step 2: Calculate Jensen's Alpha for each asset** Jensen's Alpha = Actual return - [Risk-free rate + Beta × (Market return - Risk-free rate)] - **Asset BDE**: 14% - [3% + 1.20 × 5%] = 14% - [3% + 6%] = 14% - 9% = 5% - **Asset JKL**: 13% - [3% + 0.90 × 5%] = 13% - [3% + 4.5%] = 13% - 7.5% = 5.5% - **Asset MNO**: 13% - [3% + 1.00 × 5%] = 13% - [3% + 5%] = 13% - 8% = 5% - **Asset STU**: 10% - [3% + 0.80 × 5%] = 10% - [3% + 4%] = 10% - 7% = 3% **Step 3: Identify assets with Jensen's Alpha ≥ Market Risk Premium (5%)** - BDE: 5% ✓ - JKL: 5.5% ✓ - MNO: 5% ✓ - STU: 3% ✗ (excluded) **Step 4: Calculate Marginal VaR for eligible assets** Marginal VaR = (VaRₚ/Valueₚ) × Beta Since VaRₚ/Valueₚ is constant for all assets, we can compare using Beta alone: - BDE: Beta = 1.20 - JKL: Beta = 0.90 - MNO: Beta = 1.00 **Step 5: Select asset with lowest Marginal VaR** Among the eligible assets (BDE, JKL, MNO), Asset JKL has the lowest Beta (0.90), and therefore the lowest Marginal VaR. **Final Decision**: Asset JKL should be selected as it has Jensen's Alpha (5.5%) greater than the market risk premium (5%) and the lowest Marginal VaR among eligible assets.
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A money manager who has recently received a small amount of new capital is planning to invest this capital into an existing fund, which is benchmarked to an index. Rather than investing in a new asset to be included in the fund, the manager is planning to increase the holding of one of the fund's four assets. Information about these assets, and their performances during the most recent evaluation period, are given below:
| Asset | Portfolio weight | Return | Volatility of return | Beta to the portfolio |
|---|---|---|---|---|
| BDE | 0.35 | 14% | 19% | 1.20 |
| JKL | 0.30 | 13% | 18% | 0.90 |
| MNO | 0.25 | 13% | 16% | 1.00 |
| STU | 0.10 | 10% | 10% | 0.80 |
The portfolio manager wants to select the asset that has the lowest marginal VaR as long as its Jensen's alpha is greater than or equal to the market risk premium. Assuming the risk-free interest rate is 3% and the market return is 8%, which asset should the portfolio manager select?
A
Asset BDE
B
Asset JKL
C
Asset MNO
D
Asset STU