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Consider three risky assets with the following attributes: Asset 1 Expected Return Standard Deviation 12% 22% Asset 2 5% 10% Asset 3 15% 18% The

Consider three risky assets with the following attributes:

Asset 1

Expected Return

Standard Deviation

12%

22%

Asset 2

5%

10%

Asset 3

15%

18%

The risk-free rate is 2%. The covariance matrix for the assets is:

Asset 1

Asset 2

Asset 3

Asset 1

Asset 2

Asset 3

0.0484

0.0110

0.0198

0.0110

0.0100

0.0090

0.0198

0.0090

0.0324

Assume short-selling is allowed.

  1. What is the correlation between Asset 1 and Asset 2?
  2. If one cannot invest in the risk-free security, what is the best portfolio that earns a 13% expected return?
  3. Explain concisely in a sentence or two how you solved part (b).
  4. What are the weights, expected return and standard deviation of the tangency portfolio?
  5. Explain concisely in a sentence or two how you solved part (d).
  6. If one can invest in the risk-free security (either long or short), what is the best portfolio you can hold that earns a 13% expected return? Specify the weights in the risk-free asset, Assets 1, 2 and 3 as well as the portfolio’s standard deviation.

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Expected Return Standard Deviation variance Asset 1 12 22 00484 Asset 2 5 10 001 Asset 3 15 18 00324 ... blur-text-image

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