Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Consider the following capital market: a risk-free asset yielding 0.75% per year and a mutual fund consisting of 70% stocks and 30% bonds. The expected

Consider the following capital market: a risk-free asset yielding 0.75% per year and a mutual fund consisting of 70% stocks and 30% bonds. The expected return on stocks is 10.75% per year and the expected return on bonds is 3.25% per year. The standard deviation of stock returns is 30.00% and the standard deviation of bond returns 8.75%. The stock, bond and risk-free returns are all uncorrelated.

1. What is the expected return on the mutual fund?

8.50%

2. What is the standard deviation of returns for the mutual fund?

21.16%

Now, assume the correlation between stock and bond returns is 0.45 and the correlations between stock and risk-free returns and between the bond and risk-free returns are 0 (by construction, correlations with the risk-free asset are always zero).

3. What is the standard deviation of returns for the mutual fund? Is it higher or lower than the standard deviation found in part 2? Why?

22.30%

Now, assume that the standard deviation of the mutual fund portfolio is exactly 20.25% per year and a potential customer has a risk-aversion coefficient of 2.25.

4. What correlation between the stock and bond returns is consistent with this portfolio standard deviation?

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Financial Management Principles And Practice

Authors: Timothy Gallagher

6th Edition

1930789157, 978-1930789159

More Books

Students also viewed these Finance questions

Question

What are negative messages? (Objective 1)

Answered: 1 week ago