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3. Three investments are provided as follow: Investment X: Risky asset; 15% return, 1600 % 2 variance Investment Y: Risky asset; 10% return, 225%
3. Three investments are provided as follow: Investment X: Risky asset; 15% return, 1600 % 2 variance Investment Y: Risky asset; 10% return, 225% variance Investment Z: Risk-free asset; 6% return The correlation of the return for X and Y is exactly - 1. (a) (2 points) State the volatility of X and Y. (b) (2 points) Write the volatility of a portfolio P1, with x invested in investment X and (1-x) invested in investment Y. (0 x1) (c) (3 points) Find the value of x such that a portfolio P2 formed is risk-free. What is the risk-free rate from P2? (d) (2 points) The risk-free rate you obtained from P2 is higher than that from Investment Z. Will anyone actually invest in investment Z then, why? Assume that everyone thinks that higher return is always better. Because of such an action, what do you think for the future price of the portfolio P2; will it increase or decrease?
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