A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long term bond fund, and the third is a T-Bill money market fund that yields a sure rate of return of 4.00%. The probability distributions of the risky funds are:

	Expected return	Standard Deviation
Stock fund (S)	12%	20%
Bond Fund (B)	6%	10%

The correlation between the fund return is 0.2

a. Tabulate and draw the investment opportunity set of the two risky funds. Use investment proportions for the stock fund of 0% to 100% in increments of 20%

Compute reward to variability ratio for each of the portfolio. What expected return and standard deviation does your graph show for the minimum variance portfolio? (Determine approximate point visually).

b. Draw a tangent from the risk-free rate to the opportunity set. What does you graph show for the expected return and standard deviation of the optimal risky portfolio? (Determine the approximate location of the optimal portfolio visually).

c. What is the reward to variability ratio of the best feasible CAL out of the portfolios in part b?

d. Suppose now that your portfolio must yield an expected return of 9% and be efficient, that is, on the best feasible CAL. What is the standard deviation of your portfolio?

e. If you were to use only the two risk funds and still require an expected return of 9% what would be the investment proportion of your portfolio? Compare its standard deviation to that of the optimal portfolio in the previous problem. What do you conclude?