Question

1. Assume that every investor splits his money optimally between the risk-free asset and the market portfolio (i.e., the CAPM holds). Ray Dalio has $200B under management and invests $1B in Coke, $0.5B in Amgen, $0.5B in CVS, and $30B in Treasury bonds. What do these portfolio holdings imply about the relative market capitalization of Coke and Amgen? Explain your answer.

2. You consider investing in a start-up that develops a cool new technology. The start-up will either fail within a year or you quadruple your investment. The success probability is not known, but you can assume that the success/failure for this start-up is completely random and does not depend on how the economy or the stock market are performing. According to CAPM, what rate of return should you expect from investing in this start-up?

Answer 1

1) Assigning very low weights to Coke and Amber out of the total portfolio, and investing majorly in Treasury bonds, indicated that these two stocks are having very high growth potential, but a very high risk too, which is counterbalanced by investing majorly into treasury bonds at the risk-free rate.