A pension fund manager is considering three mutual funds for investment. The first one is a stock fund, the second is a bond fund and the third is a money market fund. The money market fund yields a risk-free return of 4%. The inputs for the risky funds are given in the following table.
Fund Expected Return Standard Deviation
Stock fund.....................14%................................26%
Bond fund.......................8%................................14%
The correlation coefficient between the stock and the bond funds is 0.20.
a. What is the expected return and the variance for a portfolio that invests 60% in the stock fund and 40% in the bond fund?
b. What is the expected return and the variance for a portfolio that invests 60% in the stock fund and 40% in the money market fund?
c. Compare the portfolios in parts a and b with a portfolio that is invested entirely in the bond fund.