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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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