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Consider two risky assets with the following attributes: E[R] Stock 1 80% 50% Stock 2 20% 30% Suppose the two stocks have correlation = 0.6

Consider two risky assets with the following attributes:

E[R]

Stock 1

80%

50%

Stock 2

20%

30%

Suppose the two stocks have correlation = 0.6

table for various portfolios of the two stocks:

y

1 - y

E[R]

st dev

-0.2

1.2

8.00%

31.05%

-0.1

1.1

14.00%

30.27%

0

1

20.00%

30.00%

0.1

0.9

26.00%

30.27%

0.2

0.8

32.00%

31.05%

0.3

0.7

38.00%

32.31%

0.4

0.6

44.00%

34.00%

0.5

0.5

50.00%

36.06%

0.6

0.4

56.00%

38.42%

0.7

0.3

62.00%

41.04%

0.8

0.2

68.00%

43.86%

0.9

0.1

74.00%

46.86%

1

0

80.00%

50.00%

1.1

-0.1

86.00%

53.25%

1.2

-0.2

92.00%

56.60%

Question: 1

If you target an expected return of 35%, what is the lowest standard deviation you can achieve?

Question 2

In the diagram on the following page, show the positions of the y = -0.2,0,0.2,0.4,0.6,0.8,1 portfolios (seven portfolios). Label them clearly. Then, draw the investment opportunity set as best you can. What shape does it have?

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