Asset Allocation. This is a comprehensive problem solving question about asset allocation. The ultimate goal is to find the optimal asset allocation in a simplified scenario with TWO risky-assets (stocks) and one risk-free asset. We will break down this huge question into several steps, which may help you understand the important concepts related to the problem. The information about the assets are provided as below. There are two stocks available on the market, Stock A and Stock B. There are no restrictions on stock trading, which means you may buy stocks, short-sale stocks, or buy on margin. The expected return and volatility of the two stocks are calculated using historic data, and are provided as follows Stock A: Expected return E [rA] = 8%, volatility A = 10% Stock B: Expected return E [rB ] = 10%, volatility B = 15% The correlation between the returns of the two stocks is given by AB = 0.5 The rate on the risk-free asset is fixed at rf = 5%. You may invest in the risk-free asset and earn the risk-free rate, or you may also borrow from the risk-free asset and pay the same rate. Suppose you have mean-variance preference and your utility function has the following form U = E [r] 1 2 A2 where your risk aversion coefficient is A = 5. (a) Which stock do you prefer by directly comparing their utility score? (b) Calculate the Sharpe ratio of the two stocks. Which stock do you prefer by comparing their Sharpe ratio? (Hint: S = E[r]rf ) (c) If your preference in (b) is different from that in (a), can you briefly explain why?