Gordon, an elderly investor, has a degree of risk aversion of A = 3 when applied to return on wealth over a one-year horizon. he is pondering two portfolios. the S&P/TSX Composite Index and a hedge fund, as well as a number of one-year strategies. (all rates are annual and continuously compounded.) The S&P/TSX Composite risk-premium is estimates at 5% per year, with a standard deviation of 20%. The hedge fund risk-premium is estimated at 10% with a standard deviation of 35%. The returns on these portfolios in any particular year are uncorrelated with its own returns in other years. They are also uncorrelated with the returns of each other in any other years. The hedge fund claims the correlation coefficient between the annual return on the S&P/TSX Composite and the hedge fund return in the same year is zero, but Gordon is not fully convinced by this claim. a) Compute the estimated annual risk premiums, standard deviations and Sharpe ratios for the 2 portfolios. b). Assuming the correlation between the annual returns of the two portfolios is indeed zero, what would be the optimal asset allocation? c). What would be Gordon's asset allocation? d). If the correlation coefficient between annual portfolios returns is actually 0.3, what is the covariance between the returns? e). Assuming the correlation between the annual returns of the two portfolios is 0.3, what would be the optimal asset allocation? f). What would be Gordon's asset allocation if correlation is 0.3? Gordon, an elderly investor, has a degree of risk aversion of A = 3 when applied to return on wealth over a one-year horizon. he is pondering two portfolios. the S&P/TSX Composite Index and a hedge fund, as well as a number of one-year strategies. (all rates are annual and continuously compounded.) The S&P/TSX Composite risk-premium is estimates at 5% per year, with a standard deviation of 20%. The hedge fund risk-premium is estimated at 10% with a standard deviation of 35%. The returns on these portfolios in any particular year are uncorrelated with its own returns in other years. They are also uncorrelated with the returns of each other in any other years. The hedge fund claims the correlation coefficient between the annual return on the S&P/TSX Composite and the hedge fund return in the same year is zero, but Gordon is not fully convinced by this claim. a) Compute the estimated annual risk premiums, standard deviations and Sharpe ratios for the 2 portfolios. b). Assuming the correlation between the annual returns of the two portfolios is indeed zero, what would be the optimal asset allocation? c). What would be Gordon's asset allocation? d). If the correlation coefficient between annual portfolios returns is actually 0.3, what is the covariance between the returns? e). Assuming the correlation between the annual returns of the two portfolios is 0.3, what would be the optimal asset allocation? f). What would be Gordon's asset allocation if correlation is 0.3
