Percival Hygiene has $10 million invested in long-term corporate bonds. This bond portfolios expected annual rate of return is 9%, and the annual standard deviation is 12%. Amanda Reckonwith, Percivals financial adviser, recommends that Percival consider investing in an index fund that closely tracks the Standard & Poors 500 index. The index has an expected return of 14%, and its standard deviation is 18%.

Suppose Percival puts all his money in a combination of the index fund and Treasury bills. Can he thereby improve his expected rate of return without changing the risk of his portfolio? The Treasury bill yield is 6%.

Could Percival do even better by investing equal amounts in the corporate bond portfolio and the index fund? The correlation between the bond portfolio and the index fund is +0.2.