Question
3. A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond
3. A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a sure rate of 4.9%. The probability distributions of the risky funds are:
Stock fund (S) | 10% | 39% |
Bond fund (B) | 5% | 33% |
The correlation between the fund returns is 0.0030.
What is the expected return and standard deviation for the minimum-variance portfolio of the two risky funds?
Hint: Use the formula and parameters:
The parameters of the opportunity set of possible portfolios are:
E(rS) = 10%, E(rB) = 5%, S = 39%, B = 33%, = 0.0030, rf = 4.9%
The covariance between stocks and bonds is calculated as:
Cov(rS, rB) = SB
wmin(S) | = | B2 Cov(rS, rB) |
S2 + B2 2Cov(rS, rB) |
Variance for the min-var portfolio:
Min = [wS2S2 + wB2B2 + 2wSwB Cov(rS, rB)]1/2
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