Here are some characteristics of two securities:

Security 1 E[R1] = .10 1 = .05

Security 2 E[R2] = .16 2 = .08

Answer the following questions:

(a) Which security should an investor choose if she wants to (i) maximize expected returns, (ii) minimize risk (assume the investor cannot form a portfolio)?

(b) Suppose the correlation of returns on the two securities is +1.0. What is the optimal portfolio of securities 1 and 2 for an investor whose objective is to minimize risk. Assume that short sales are not allowed?

(c) Suppose the correlation of returns is -1.0. What weights should the investor put on these two securities to get a portfolio that has zero risk?

(d) What is the expected return on the portfolio in (c)? Suppose the yield on Treasury bills, i.e., the riskless rate, is 10%. Describe how you would make an arbitrage?