Question
Greg and Maria are about to invest $1,000,000. They have three options to invest in, a risk free asset (T-bill) offering 5%, asset A with
Greg and Maria are about to invest $1,000,000. They have three options to invest in, a risk free asset (T-bill) offering 5%, asset A with an expected return of 20% and standard deviation of return of 30%, and asset B with an expected return of 20% and standard deviation of return of 40%. The two assets are uncorrelated (the correlation between the two assets is zero). They intend to allocate part of their $1,000,000 to investing in risk-free asset and the rest of it to securities A, B, or both. Greg believes that, because securities A and B have the same expected return but Security B has higher risk, they should invest only A in combination with the risk free asset. Maria believes they should invest in all three opportunities (T-bill, A, and B). If their maximum risk tolerate is 12% (they want the standard deviation of their portfolio be 12%), how should they allocate their $1,000,000 between T-bill and risky assets? Show your work. Again, support your answer numerically.
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