Consider the following classic portfolio choice problem. Two assets are available to an investor at time t. One is riskless, with simple returnRffrom timettot+1, and the other is risky. The

risky asset has simple returnRfrom timettot+1. The investor puts a sharewof his portfolio into the risky asset. We assume that the investor trades off mean and variance in a linear fashion. That is, investor maximizes a linear combination of mean and variance, with a positive weight on mean and a negative weight on variance:

represent and why?

1. a)(7 marks)What is the proportion of wealth invested in risky asset?
2. b)(8 marks) Explain two-fund separation in relation to your answer in part (a). What does k represent and why?