8. Risk and return Suppose Caroline is choosing how to allocate her portfolio between two asset classes: risk-free government bonds and a risky group of diversied stocks. The following table shows the risk and return associated with different combinations of stocks and bonds. Frach'on of Portfolio in Diversied Average Annual Standard Deviation of Portfolio Retun'l Stocks Return (Risk) Combinalion (Percent) (Percent) (Percent) A D 1.50 CI B 25 2.50 5 C SCI 3.50 10 D 75 4.50 15 E 100 5.50 20 As the risk of Carolina's portfolio increases, the average annual return on her portfolio V . Suppose Caroline currently allocates 25% of her portfolio to a diversified group of stocks and 75% of her portfolio to risk-free bonds; that is, she chooses combination B. She wants to increase the average annual return on her portfolio from 2.5% to 4.5%. In order to do so, she must do which of the following? Check all that apply. [3 Accept more risk C] Sell some of her stocks and use the proceeds to purchase bonds D Sell some of her bonds and use the proceeds to purchase stocks C] Sell some of her stocks and place the proceeds in a savings account The table uses the standard deviation of the portfolio's return as a measure of risk. A normal random variable, such as a portfolio's return, stays within two standard deviations of its average approximately 95% of the time. Suppose Caroline modifies her portfolio to contain 75% diversied stocks and 25% risk-free government bonds; that is, she chooses combination D. The average annual return for this type of portfolio is 4.5%, but given the standard deviation of 15%, the returns will typically (about 95% of the time) vary from a gain of V to a loss of V