Consider the following two risky assets and the portfolio formed by investing 80% in ABC, 20% in XYZ. ABC and XYZ have a correlation of -0.4.

The minimum variance portfolio has weights wABC = .3261 and wXYZ = .6739

a)

Find the expected return and standard deviation of the minimum variance portfolio.

b)

Graph and label your answer for part (a) the minimum variance portfolio, on the graph on the next page. Note ABC and XYZ have already been graphed, as well as the 80 ABC /20 XYZ portfolio.

c)

Sketch and label the investment opportunity set generated by the two risky assets.

d)

Label the efficient frontier of risky assets.

e)

Suppose the risk-free rate is 4%. Sketch and label the Capital Allocation line of the optimal risky portfolio of the two risky assets. (You do not need to calculate the optimal risky portfolio, just show it on the graph.)

f)

Looking at your graph and comparing the optimal portfolio to the minimum variance and 80/20 portfolio, what do you think are the approximate weights of ABC and XYZ in the optimal portfolio?

Graph:

Std Dev Expected Return | 22% XYZ 7% | Portfolio (80 % ABC 20 % XYZ | 19 % 25 % 15 % 19 % ABC Expected Return XYZ 0 0.05 0.1 0.15 0.2 0.25 0.3 Std. Dev Std Dev Expected Return | 22% XYZ 7% | Portfolio (80 % ABC 20 % XYZ | 19 % 25 % 15 % 19 % ABC Expected Return XYZ 0 0.05 0.1 0.15 0.2 0.25 0.3 Std. Dev