Question
Assets Expected Return Standard Deviation Stock A 17% 23% Stock B 23% 45% The correlation coefficient between the returns of the stock fund and the
Assets | Expected Return | Standard Deviation |
Stock A | 17% | 23% |
Stock B | 23% | 45% |
The correlation coefficient between the returns of the stock fund and the bond fund is 0.35. The return on the risk-free asset is 2%.
Calculate the risk and returns of a portfolio using proportions of the stocks A and B from 0 to 100% in increments of 25%. Round to the fourth decimal (X.XXXX) and tabulate your results below. (1 pt each, 10 total)
Weight in A | Weight in B | Expected Return | Standard deviation |
0 | 1 | 23 | 45 |
0.25 | 0.75 | 12.5 | 36 |
0.5 | 0.5 | 20 | 28 |
0.75 | 0.25 | 18.5 | 23 |
1 | 0 | 17 | 23 |
Calculate the weights of the two assets that form the optimal risky portfolio. Also compute the expected return and standard deviation of the optimal risky portfolio (5pt)
What is the highest attainable Sharpe ratio for the efficient frontier? (Hint: calculate the expected return and the standard deviation of the optimal risky fund). (5pt)
Use your results from parts a), b), c ) and d) to accurately draw the investment opportunity set of the two risky assets. Clearly label the Y and X axes. Find the minimum variance portfolio, the optimal risky portfolio, the risk free rate, and draw the efficient frontier. Also draw the Capital Allocation Line (CAL) from part d) (5pt)
Analysis: What is the Sharpe ratio? Why would a rational investor prefer the CAL in part e) over any other CAL? (5 pt)
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