Portfolio Management

1. You are evaluating various investment opportunities currently available for you and identified two mutual funds that you are interested in: equity (stock) fund and long- term bond fund. You have calculated the expected returns and risks for the two funds as follows: Expected Return Standard Deviation Equity fund 15.12% 12.24% Bond fund 6.48% 3.96% The correlation between the equity and bond funds is -0.2. a) Find the investment proportions (weights) of the optimal risky portfolio and compute its expected return and risk. [8 marks] b) Calculate the expected returns and risks for at least 4 portfolios that combine the two risky funds in different proportions and use them to graphically represent the efficient frontier. [7 marks] c) With reference to Portfolio Theory, briefly explain what is meant by an efficient frontier. How would the efficient frontier in part b) look like if the correlation coefficient had been -1? [8 marks] | [Word limit: 200] d) Assuming that you can invest in cash at 1.60% risk-free rate, sketch the new opportunity set (CAL) that includes the risk-free asset along with the optimal risky portfolio. Explain how you can move along the line. [7 marks] | [Word limit: 150]